Bangladesh selling Sovereign Bond to Cope with Financial Crisis

Sovereign Bond Bangladesh

By- Bangladesh News Bureau | Date- April 09, 2012

Bangladesh Awami League led coalition government of leftists and former dictator, for the first time in the history of the country, has decided to sell sovereign bond in the international stock market to cash US$ 500 million to cope with the current acute shortage of foreign currency reserve. The government is forced in taking this decision of collecting money by selling bonds though it will cost higher interest rate to the country. Financial experts have already warned the government stating the issuance of sovereign bonds bears high risks.

Bangladesh Bank (central bank of the country) suggested the government to collect foreign currency by selling sovereign bond in the international stock market to cope with the current crisis in foreign exchange reserve. Taking the tips of the central bank into active consideration, the government formed a committee with senior officials of the finance ministry to assess the risks and scopes in issuance of such bond. Recently the committee has submitted its recommendations to the government. The committee said, sovereign bond may be issued during the next fiscal year, though the government needs to evaluate the entire issue in comprehensive manner before proceeding with the final steps of the issuance of the sovereign bond. It also said, though the rate of interest on sovereign bond are currently at a lower rate in the international stock market, the continuous devaluation of Bangladesh Taka against US dollar as well as decline in foreign currency reserve may put adverse affect on such issuance. It also said, the domestic economy of the country should be stable prior to issuance of sovereign bond.

Generally, sovereign bonds are issued for five or ten year term. The committee has suggested Bangladesh to make the term of the first issuance of the bond to maximum five years, though some of the top policymakers in the ruling party are suggesting issuance of the bond for a period of ten years. It is also suggesting the government to issue multiple bonds with the target of cashing few hundred million dollars. It said, the government needs to issue bonds due to tremendous burden of foreign loan as well as massive devaluation of the local currency. The government may soon appoint lead manager for the purpose of issuing sovereign bond.

Commenting of issuance of sovereign bond, former finance advisor of the military controlled interim regime, Dr. Mirza Azizul Islam said, “The government may issue sovereign bond in case of necessity. But such issuance bears substantial risk factors. The issuance and usage of the sovereign bond should be done in a very careful manner. The government also needs to clearly ascertain the areas of usage of the bond money, failing which currency mismatch and maturity mismatch may occur.

A government bond is a bond issued by a national government, generally promising to pay a certain amount (the face value) on a certain date, as well as periodic interest payments. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country. Government bonds are usually denominated in the country’s own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds, although the term sovereign bond may also refer to bonds issued in a country’s own currency.

The first ever government bond was issued by the English government in 1693 to raise money to fund a war against France. It was in the form of a tontine. Later, governments in Europe started issuing perpetual bonds (bonds with no maturity date) to fund wars and other government spending. The use of perpetual bonds ceased in the 20th century, and currently governments issue bonds of limited duration.

Government bonds are usually referred to as risk-free-bonds, because the government can raise taxes or create additional currency in order to redeem the bond at maturity. Some counter examples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998 (the ruble crisis), though this is very rare. Another example is Greece in 2011. Its bonds were considered very risky, in part because Greece did not have its own currency.

Risk factor

A sovereign default is the failure or refusal of the government of a sovereign state to pay back its debt in full. It may be accompanied by a formal declaration of a government not to pay (repudiation) or only partially pay its debts (due receivables), or the de facto cessation of due payments. (Another name is national insolvency, if not willful- as in, if total assets are less than total debts.) Most authorities will limit the use of default to mean failure to abide by the terms of bonds or other debt instruments. Countries have at times escaped the real burden of some of their debt through inflation. This is not default in the usual sense because the debt is honored, albeit with currency of lesser real value. Sometimes countries end or alter the convertibility of their currency into precious metals or foreign currency at fixed rates. This is also not default in the usual sense of the word, but the remainder of this article will treat it as a default and in the list below of instances of sovereign default will include the US actions to diminish and then end the link between the dollar and gold. Calling this default is controversial, however, since all dollar owed were repaid with dollars as required by the terms of the bonds.

If potential lenders or bond purchasers begin to suspect that a government may fail to pay back its debt, they may demand a high interest rate in compensation for the risk of default. A dramatic rise in the interest rate faced by a government due to fear that it will fail to honor its debt is sometimes called a sovereign debt crisis. Governments may be especially vulnerable to a sovereign debt crisis when they rely on financing through short-term bonds, since this creates a situation of maturity mismatch between their short-term bond financing and the long-term asset value of their tax base. They may also be vulnerable to a sovereign debt crisis due to currency mismatch if they are unable to issue bonds in their own currency, as a decrease in the value of their own currency may then make it prohibitively expensive to pay back their foreign-denominated bonds.

Since a sovereign government, by definition, controls its own affairs, it cannot be obliged to pay back its debt. Nonetheless, governments may face severe pressure from lending countries. In the most extreme cases, a creditor nation may declare war on a debtor nation for failing to pay back debt, in order to enforce creditor’s rights. For example, Britain routinely invaded countries that failed to repay foreign debts, invading Egypt in 1882. Other examples include the United States’ gunboat diplomacy in Venezuela in the mid-1890s and the United States occupation of Haiti beginning in 1915. A government which defaults may also be excluded from further credit and some of its overseas assets may be seized; and it may face political pressure from its own domestic bondholders to pay back its debt. Therefore governments rarely default on the entire value of their debt. Instead, they often enter into negotiations with their bondholders to agree on a delay or partial reduction of their debt payments, which are often called a debt restructuring or haircut.

Some economists have argued that, in the case of acute insolvency crises, it can be advisable for regulators and multilateral lenders to preemptively engineer the orderly restructuring of a nation’s public debt- also called orderly default or controlled default. In the case of Greece, these experts generally believe that a delay in organizing an orderly default would hurt the rest of Europe even more.

The International Monetary Fund often assists in sovereign debt restructurings. To ensure that funds will be available to pay the remaining part of the sovereign debt, it often makes its loans conditional on austerity measures within the country, such as tax increases or reductions in public sector jobs and services. A recent example is the Greek bailout agreement of May 2010.

Reason behind pressure of foreign currency reserve

Financial experts in Bangladesh as well as officials of the ministry of finance and the central bank said, foreign currency reserve has witnessed tremendous crisis in the recent times due to high-expenditure on the quick-rental power stations. On the other hand, due to government’s excessive borrowing from the domestic banks has already caused serious liquidity crisis. The country did not get foreign investments of foreign currency remittance as per expectations for past couple of years, which has already caused alarming situation in the financial sector in Bangladesh. On the other hand, suspension of financial aids and loans from the donor agencies including the World Bank for Padma Bridge project has added the existing financial crisis in the country. They said, the government seems to be moving with its whims in anyhow implementing the Padma Bridge project ignoring the fact of current crisis in the foreign exchange reserve. Such tendencies of the current government will put long-lasting adverse effect on country’s economy as a whole.

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