Eurobond: questions begging answers

The Eurobond test is not approving the widely perceived economic recovery. In April 2014, when foreign reserves were $9.7 billion and the PIB 10-year bond yield was 12.9 percent in rupee terms, the government raised $1bn from 10 year Eurobond at 8.25 percent in dollars. Ever since, the euphoria of economic revival was built up with inflation coming down and reserves pilling up but the GDP growth remained subdued.

A year and a half later, reserves are almost doubled ($18.7bn) and inflation is at rock bottom. The risk profile in the domestic market has changed with 10-year PIB yielding down at 9.3 percent; but the global markets do not seem to have bought the recovery story as last week government issued $500 million 10 year Eurobond at 8.25 percent – similar rate as was in April 2014.

Is the economic recovery hollow on the global lens? Is there some truth in number fudging allegations? Wasn’t it the right time to issue Eurobond? Did the finance ministry give an impression of desperation? Why then despite a 356 bps reduction in domestic market long term yield; the global markets are unmoved? What is the rationale of a mere 110 bps difference in PKR and USD bond of same risk and maturity profile?

These are tough questions which have to be countered by the country’s economic management. Why Dar and the team decided and executed the bond issue in a hurry when the global financial markets are jittery loosing appetite of emerging economies? What is this obsession of building foreign reserves and fixation to currency parity? The Eurobond servicing cost is less than domestic bond only if the annual depreciation is less than 1 percent per year for the next ten years – does anyone in the country believe that?

Nonetheless, the bond is issued and there are lessons to be learned for future. The government had budgeted $1bn from Eurobond in the FY16 budget but had no intentions to go into an issue within first quarter. The decisions are based on foreign exchange targets for each quarter arbitrarily set by finance ministry. The government was expecting $1 billion by September from the ADB, World Bank and government of Japan; but due to lack of commitments of local authorities for energy reforms the disbursements are delayed.

That has urged Dar to go into the international bond market knowing that the timing is not right as the objective is to pile up reserves by one way or the other irrespective of the repercussions in the medium to long term. Had Dar waited for the dust to settle and issued the bond in more conducive conditions; the rates could have been lower. Who is responsible for such high servicing of bond? The return on incremental foreign reserves is 1-2 percent per annum while the cost of Eurobond is 8.25 percent – is there anyone out there to explain this anomaly?

The blessing in disguise from this mismanaged issue is that the government refrained, reluctantly though, from expected issue of $1-1.5 billion and confined to $500 million. The experts were of the opinion to not issue more than $500 million which was the government’s target and that is what happened. But the expectations were of 5 year bond at 6.5 percent while rate of 10 year paper was anticipated at 7.5 percent.

However, the bids received were probably too high for 5 year bond and the government saved its skin to accept $500 million offered on 10 year paper at rates equal or below the previous issue. The government issued the bond in a hurry with no time to do proper marketing. Even the African countries sovereign bond rates are lower than Pakistan’s.

This should be the wakeup call for Dar and company to work on a sustainable way of building reserves and to focus on economic growth and come up with export boosting policies. But the fixation to currency parity is eluding the prospects. The bottom line is that $500 million each is coming from Eurobond and IMF’s tranche and soon the reserves will cross $20 billion to make another headline!