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EASY MONEY: IMPLICATIONS OF ARMENIA'S RECENT SOVEREIGN BOND ISSUANCE
http://hetq.am/eng/articles/29744/easy-money-implications-of-armenia%E2%80%99s-recent-sovereign-bond-issuance.html
11:38, October 1, 2013
On Thursday, September 19, 2013, Armenia issued its first sovereign
US$-denominated bond and joined Bolivia, Namibia, Nigeria, Rwanda,
Mongolia, and a handful of other (mostly low-income) countries that
within the past year or so entered the international market for the
first time.
Armenia's bond issue had the following characteristics: it had a size
of US$700 million; a repayment period of 7 years; carried a coupon of
6 percent annually; and was sold below the asking price, yielding a
total of 6.25 percent per year for investors, if they hold the bond
to maturity.
The issue is rumored to be nicknamed "Kardashian", after the famous
US TV personalities, the Kardashian family. In should be noted that
Armenia's credit rating is in "junk" (i.e., non-investment/speculative)
territory, as per both Moody's (Ba2) and Fitch (BB-) rating
agencies. Finally, Deutsche Bank, HSBC, and J.P.
Morgan Chase-the banks, which helped close the deal-were paid an
estimated US$5 million for this transaction.
What is behind this move by the government of Armenia and what would
be the relevant criteria for evaluating such a step?
The use of the proceeds raised by selling the bond is perhaps the
most important criteria for judging the effectiveness in all such
cases. As we indicated in "Armenia: Avoiding an Economic Catastrophe",
Armenia has to repay US$1 billion until the end of 2014, most of which
to the International Monetary Fund (IMF). However, according to a
recent IMF statement, Armenia may get a new loan from that financial
institution, which will enable its government to roll over the debt
payments falling due.
The second portion of government's debt coming due is owed to Russia.
Although it is unclear whether Armenia's (disastrous) commitment
to join the Russia-led Customs Union will have any implications on
the debt servicing, it is entirely conceivable that the portion of
Armenia's debt owed to Russia too will get rolled over because of
that commitment. Should this be the case, the Armenian government
will have the entire US$700 million to spend as it pleases!
There are several reasons why issuing this bond now was a very bad
idea from the country's and its average citizen's perspective:
First, much like in 2009, the government of Armenia has no
developmental plan to speak of, and is likely to spend the proceeds
of the bond on boosting current expenditures, such as, increasing
pensions and salaries and providing a subsidy for imported Russian
gas. Both of these expenditure categories will help ease the social
tension in the country and thus help the Sargsyan regime delay the
unavoidable. These expenditures will not, however, result in job
creation or investment and could therefore be viewed as wasteful.
Second, given the extent of budgetary leaks in Armenia (see PFA's
estimates contained in our Diaspora Report, on page 34), this will
be a lucrative opportunity for top-level officials to become even
wealthier. Once the US$700 million are deposited at the Central Bank
(CBA) and in return the dram-denominated equivalent of that money is
deposited at the government's account at the CBA, this becomes like
any other government revenue, subject to the same corrupt "ways and
means". An estimated 20-30 percent of these funds will eventually be
embezzled through various procurement malpractices and other loopholes
employed by the Armenian government.
Third, unless used to repay existing debt coming due, this bond
issuance adds an additional 8 percent of GDP to Armenia's public debt
and requires payments of US$42 million in interest cost per year, for
7 years in a row. Since the interest paid on this bond is much higher
than that presently accrued on Armenia's debt (much of which is still
on concessional terms due to Armenia's low per capita income), the
bond deal increases the country's debt burden disproportionately and
brings Armenia one large step closer to debt distress. It is partially
for these reasons that following the announcement of the Armenian bond
issue Moody's lowered its foreign-currency bond ceiling on Armenia.
Fourth, in practice most of these large sovereign bonds are never
repaid-once issued (and the money is spent!) they are rolled over,
perpetuating the country's debt overhang. When the time comes to
roll over this particular bond in 7 years, chances are the global
economy will be at its peak (or thereabouts) with interest rates
being much higher than now, potentially costing the country a lot
more than 6.25 percent to issue a new bond. In the meantime, once
the international rates start going up (expected to happen beginning
early-2014), the Armenian bond will trade down (this is a feature of
bonds with a fixed-rate coupon to lose value when interest rates go
up), selling below the initial face value.
Fifth, while the timing is indeed opportune (given that the
global conditions have softened following the US Federal Reserve's
announcement to leave its unconventional monetary policy unchanged),
this deal will not have the benefits that most first-time sovereign
bond issues carry. One of the mains reasons behind these sovereign
bond issues is to act as benchmarks against which the local (in
this case, Armenian) companies could issue bonds in capital markets
(both international and domestic). Clearly, with the outlook for the
Armenian economy looking increasingly gloomy, there is likely to be
very little, if any, appetite from the private sector companies to
issue bonds any time soon. Therefore, what could have been a useful
guide for the private sector in better times will get mostly ignored
and its potential benefits wasted.
But perhaps the most important reason why it is a bad idea for this
government to have all this money is because it will undoubtedly
reduce their incentive to reform and take the economy out of the
dire situation it is in. As any other easy money (or what the famous
Harvard economist of the 1980s, Janos Kornai, would call soft budget
constraint), this bond will buy them time and reduce their incentives
to search for solutions to problems facing the economy (Not that they
had those incentives to begin with, but still).
We wonder if the Kardashian family would still be pleased to have
their name associated with this bond, if they knew about all of this.
We will keep our views on this one to ourselves!
Is there a silver lining in all of this, you may ask? Unfortunately,
none, especially if our conjecture regarding the use of the bond money
(as outlined above) becomes true.
pfarmenia.wordpress.com
From: Baghdasarian
http://hetq.am/eng/articles/29744/easy-money-implications-of-armenia%E2%80%99s-recent-sovereign-bond-issuance.html
11:38, October 1, 2013
On Thursday, September 19, 2013, Armenia issued its first sovereign
US$-denominated bond and joined Bolivia, Namibia, Nigeria, Rwanda,
Mongolia, and a handful of other (mostly low-income) countries that
within the past year or so entered the international market for the
first time.
Armenia's bond issue had the following characteristics: it had a size
of US$700 million; a repayment period of 7 years; carried a coupon of
6 percent annually; and was sold below the asking price, yielding a
total of 6.25 percent per year for investors, if they hold the bond
to maturity.
The issue is rumored to be nicknamed "Kardashian", after the famous
US TV personalities, the Kardashian family. In should be noted that
Armenia's credit rating is in "junk" (i.e., non-investment/speculative)
territory, as per both Moody's (Ba2) and Fitch (BB-) rating
agencies. Finally, Deutsche Bank, HSBC, and J.P.
Morgan Chase-the banks, which helped close the deal-were paid an
estimated US$5 million for this transaction.
What is behind this move by the government of Armenia and what would
be the relevant criteria for evaluating such a step?
The use of the proceeds raised by selling the bond is perhaps the
most important criteria for judging the effectiveness in all such
cases. As we indicated in "Armenia: Avoiding an Economic Catastrophe",
Armenia has to repay US$1 billion until the end of 2014, most of which
to the International Monetary Fund (IMF). However, according to a
recent IMF statement, Armenia may get a new loan from that financial
institution, which will enable its government to roll over the debt
payments falling due.
The second portion of government's debt coming due is owed to Russia.
Although it is unclear whether Armenia's (disastrous) commitment
to join the Russia-led Customs Union will have any implications on
the debt servicing, it is entirely conceivable that the portion of
Armenia's debt owed to Russia too will get rolled over because of
that commitment. Should this be the case, the Armenian government
will have the entire US$700 million to spend as it pleases!
There are several reasons why issuing this bond now was a very bad
idea from the country's and its average citizen's perspective:
First, much like in 2009, the government of Armenia has no
developmental plan to speak of, and is likely to spend the proceeds
of the bond on boosting current expenditures, such as, increasing
pensions and salaries and providing a subsidy for imported Russian
gas. Both of these expenditure categories will help ease the social
tension in the country and thus help the Sargsyan regime delay the
unavoidable. These expenditures will not, however, result in job
creation or investment and could therefore be viewed as wasteful.
Second, given the extent of budgetary leaks in Armenia (see PFA's
estimates contained in our Diaspora Report, on page 34), this will
be a lucrative opportunity for top-level officials to become even
wealthier. Once the US$700 million are deposited at the Central Bank
(CBA) and in return the dram-denominated equivalent of that money is
deposited at the government's account at the CBA, this becomes like
any other government revenue, subject to the same corrupt "ways and
means". An estimated 20-30 percent of these funds will eventually be
embezzled through various procurement malpractices and other loopholes
employed by the Armenian government.
Third, unless used to repay existing debt coming due, this bond
issuance adds an additional 8 percent of GDP to Armenia's public debt
and requires payments of US$42 million in interest cost per year, for
7 years in a row. Since the interest paid on this bond is much higher
than that presently accrued on Armenia's debt (much of which is still
on concessional terms due to Armenia's low per capita income), the
bond deal increases the country's debt burden disproportionately and
brings Armenia one large step closer to debt distress. It is partially
for these reasons that following the announcement of the Armenian bond
issue Moody's lowered its foreign-currency bond ceiling on Armenia.
Fourth, in practice most of these large sovereign bonds are never
repaid-once issued (and the money is spent!) they are rolled over,
perpetuating the country's debt overhang. When the time comes to
roll over this particular bond in 7 years, chances are the global
economy will be at its peak (or thereabouts) with interest rates
being much higher than now, potentially costing the country a lot
more than 6.25 percent to issue a new bond. In the meantime, once
the international rates start going up (expected to happen beginning
early-2014), the Armenian bond will trade down (this is a feature of
bonds with a fixed-rate coupon to lose value when interest rates go
up), selling below the initial face value.
Fifth, while the timing is indeed opportune (given that the
global conditions have softened following the US Federal Reserve's
announcement to leave its unconventional monetary policy unchanged),
this deal will not have the benefits that most first-time sovereign
bond issues carry. One of the mains reasons behind these sovereign
bond issues is to act as benchmarks against which the local (in
this case, Armenian) companies could issue bonds in capital markets
(both international and domestic). Clearly, with the outlook for the
Armenian economy looking increasingly gloomy, there is likely to be
very little, if any, appetite from the private sector companies to
issue bonds any time soon. Therefore, what could have been a useful
guide for the private sector in better times will get mostly ignored
and its potential benefits wasted.
But perhaps the most important reason why it is a bad idea for this
government to have all this money is because it will undoubtedly
reduce their incentive to reform and take the economy out of the
dire situation it is in. As any other easy money (or what the famous
Harvard economist of the 1980s, Janos Kornai, would call soft budget
constraint), this bond will buy them time and reduce their incentives
to search for solutions to problems facing the economy (Not that they
had those incentives to begin with, but still).
We wonder if the Kardashian family would still be pleased to have
their name associated with this bond, if they knew about all of this.
We will keep our views on this one to ourselves!
Is there a silver lining in all of this, you may ask? Unfortunately,
none, especially if our conjecture regarding the use of the bond money
(as outlined above) becomes true.
pfarmenia.wordpress.com
From: Baghdasarian