Easy Money: Implications of Armenia’s Recent Sovereign Bond Issuance

There are a lot of reasons why Armenia’s issue of its first sovereign bond issue was a bad idea. Policy Forum Armenia has published an interesting analysis, listing a total of 6 reasons.

  • 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).

Read the full analysis here.