How Could the Government Save Some Money and Reduce Foreign Debt at Once?

Not long ago the Bulgarian National Bank (BNB) released preliminary data for the country’s gross foreign debt that was EUR 14,3 billion at the end of January this year or approximately 60,7 % of the prognosticated GDP for 2006. Among others, this figure contains the debt of the government sector (EUR 4,15 billion), which, although has been constantly declining since 2001, shows that every Bulgarian taxpayer owed money to the rest of the world in the amount of EUR 1 393(1) .

The gross government debt is solely long-term, nearly evenly split between non-securitized loans (simple credits) and bond-bounded debts, namely the eurobonds and the global bonds issued on international markets by the previous Bulgarian government.

I purposely do not take it into account that part of the issued bonds (about 1/5) are held by residents of Bulgaria and thus do not represent a foreign but an internal debt. In the current situation this is an accurate approach by all means, bearing in mind that part of the bonds issued inside the country are respectively held by non-residents and are de facto considered as liabilities to the rest of the world. On the other hand, as it has already been pointed out, the aggregate public debt comprises also the obligations of government enterprises and government bails.

The parameters of the issued government bonds are as follows:

 

Value

(EUR, millions)

Maturity

Annual interest rate

Market price

(% of nominal, 01.01.06)

Eurobonds

250

03.2007

7,25 %

105 %

Global bonds in euro

835,5

01.2013

7,50 %

124 %

Global bonds in dollars

1 050

01.2015

8,25 %

121 %

Source:BNB; Ministry of Finance

 

If the government is willing to manage the foreign debt, there are numerous possible combinations: starting with buying back all securities today and going all the way long to paying what needs to be paid bit by bit. The choice of action depends generally on the financial sustainability of the country and the predominant expectations of the authorized government officials for the future development of the market. We could not know what are the exact expectancies for the market, though we are quite able to know what financial resources the government is disposing of.

According to the latest figures released by the Ministry of Finance, the current fiscal reserve (the amount of the annual budget revenue that exceeds the expenditures) is slightly over 4,25 billion. For the second year in a row, the minimal reserve that is to be kept must not fall under 2,5 billion, which means that the rest of about 1,75 billion leva could be imperturbably spent on paying off government debts.

Of course this could be the case if the government has not already figured out a “better” use of the money like investing into a huge project in atom energy sector or, which is nearly the same – bailing private investments there. There is also a need to bear in mind that almost all financial resources are put into accounts at the Bulgarian National Bank and the interest rates they bring to their owners (i.e. budget) are miserable and are not more than 2,5 % annually.

 

What else could the government do with an over-reserve of 1,75 billion leva?

  1. To buy right away all eurobonds at 105 % of the nominal price, which would cost EUR 262,5 million or to wait for about a year to the maturity and to pay then 268,125 both principal and interest(2) . The net present value of these 268,125 million, payable in one year at a 2,5 % discount rate is EUR 261,58 millions. Since it is about a million cheaper, it is right to await the maturity.
  2. Buying back the global bonds now and today would cost the reserve EUR 1 036 million. If one wait for the maturity, which is in 2013, then would have to be paid more according to the net present value figure – EUR 1 065,6 million, which includes both – discounted principle and interest payments (altogether six – on 15 of January). In short, if the government buys now it would save its taxpayers about EUR 29,6 million.
  3. Paying off all debts related to the global bonds in dollars now would cost EUR 1 270,5 million and paying the debt off at the maturity – altogether EUR 1 341,6 million, Figures are in favor of buying today – amount of money saved: EUR 71,1 million.

In this example I disregard the existence of transaction costs, which would make deals more expensive and thus logically less profitable. I still believe though, that the final results would be relatively unchanged. I also set aside possible alterations in market conjuncture and / or potential changes in the bond contract parameters like swaps.

To be able to save about EUR 100 million, the Bulgarian government should have at a free disposal and also agree to use about EUR 2,3 billion. That is generally an immense amount of money that not so many governments could afford to spend overnight without any serious implications on their economies. Thus, the presence of a huge fiscal over-reserve in Bulgaria allows the use of about EUR 0,9 billion (currently in foreign exchange anyway), which would pay off over 1/3 of the bond bounded government debt and save the taxpayers over 35 million leva.

Besides the opportunity to reduce foreign debt that is to be paid off soon or later anyway, there are also some other reasons backing the direction of the fiscal over-reserve to buying back bonds:

  • Raising the credit rating of the country – easier and cheaper access to credits for the government and for the private sector as well.
  • Improving interest of the international investors towards Bulgaria due to lower investment risk, financial sustainability
  • Using the accumulated, through higher than the breakeven point taxation, over-reserve in the best possible way
  • Preventing its laying out on inefficient or even harmful for the economy activities
  • And finally reducing the amount of money each taxpayer owes on average to the rest of the world.

 

 

 

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(1) The Public debt is actually higher, which is due to the fact that the government sector does not account for debts of banks and non-bank enterprises with over 50 % government participation, and for the debts guaranteed by the public sector as well.

(2) We accept that an interest for a whole year has to be paid and it is payable upon redeeming the principal.


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