Bon voyage, Bangla Bond!
Bangladesh needs to boost private investment from the current 23 percent of GDP to nearly 30 percent to accelerate and sustain growth as it moves up the middle-income path and strives to achieve the Sustainable Development Goals.
The financing needs are enormous. Infrastructure, manufacturing, construction, housing and modern services sectors require substantial financing. Most of these sectors generate revenues primarily in local currency.
Even if they could borrow in foreign currency, such borrowing will be subject to a currency mismatch exposing the borrowers to exchange rate risk. Local currency bond issuance avoids such risks, but such a market does not exist within Bangladesh.
Thus, local investors would like to borrow provided they can service such borrowing in local currency.
There are global investors interested in high-quality assets in the offshore market for various maturities offering competitive returns at affordable risk. They will not mind investing in bonds denominated in currency of the country where the bond proceeds will be used and paid back in the same currency.
A significant part of the dollar return to the buyer of the bond is thus determined by the change in the local currency-dollar exchange rate. International investors assume the exchange rate risk.
The International Finance Corporation (IFC) has floated taka bonds—Bangla Bond—in the London Stock Exchange. Bangla Bonds are taka-denominated bond on the LSE leveraging IFC’s own AAA credit rating.
The bond is expected to be principally purchased by institutional investors seeking exposure to the taka and a higher yield. The final repayment may be in hard currencies such as the US dollar or Euro, but the investors bear the risk of taka depreciation and the risk of IFC default.
This is a good time for issuing taka bonds because interest rates in hard currencies (US dollar, euro, pound sterling, yen) are at very low levels.
IFC in turn will lend the money in taka to fund its own investments, bear the risk of domestic borrower default and expect to earn a margin on the rate of interest charged to borrowers in Bangladesh.
The objective is to fund commercially viable projects to fuel domestic growth via borrowings and internationalise the Bangladesh currency.
The IFC’s Bangla Bond programme is inspired by its experience with the Masala Bond Programme launched in India in November 2013. The first tranche of $100 million under the programme was sold to a range of investors, including asset managers, banks, and a pension fund in the United States and Europe.
It succeeded in having a demonstration effect prompting additional issuances, creating an offshore rupee bond market, and testing international markets for potential internationalisation of the rupee.
The lack of currency risk on the part of domestic borrowers with such issuances widens access to a large global investor base looking for high-quality assets, which in turn allows for a larger potential programme size to be executed in offshore markets.
Dollar-settled taka bonds will enable global investors to benefit from Bangladesh’s healthy economic fundamentals while avoiding the cumbersome onshore investment routes.
Is the avoidance of the currency risk a significant advantage for the domestic borrowers? It can be, judging from the Indian experience. Following the ‘Global Financial Crisis’ in 2008 and subsequently the ‘Tapering Tantrum’ in 2013, the Indian rupee depreciated significantly against the US dollar, distressing all those entities who had gone the external commercial borrowing route to raise capital.
In 2013, the Indian rupee depreciated by about 15 percent in three months causing huge losses arising out of the currency movements to those who borrowed in foreign currency from the international markets. Those using Masala bond funds were not impacted by this fall in the value of the rupee.
What is in it for investors? Given that the investor will bear the currency risk, what benefit will entice the investor to invest in Bangla Bonds? Obviously, IFC will have to offer a much higher yield than otherwise available in the market to compensate for the risk of taka depreciation and the returns from comparable alternative investments.
The high returns therefore serve as an attraction to investors to invest in such bonds. The additional return will also have to cover for default risk, but that is not expected to be large because of IFC’s AAA rating.
Successful launching and operation of the Bangla Bond can hasten the development and maturity of the fixed income market in Bangladesh. If it really becomes popular with overseas investors, then they can be a huge support to the taka.
This has been exemplified by the rising demand for China’s Dim-Sum Bonds, which significantly promoted the use of RMB in global trade and investment as well as offered investment avenues for RMB holders based outside China.
Once established, if Bangladesh Bank allows domestic banks to issue taka bonds, it will open up an additional source of funding for the local lenders who are facing difficulties raising capital domestically. But the extent to which banks will be able to use this channel will depend on the risk appetite of foreign investors, the pricing of the bond and demand for the taka.
Like everything else there is no free lunch. The exchange rate risks rest with the issuing economy at the macro level. If the foreign investors start in hordes to redeem their holdings of the taka bonds because of weak macroeconomic fundamentals, rise in international interest rates or increased global political and economic risks, the taka will face depreciation pressure.
While Bangla Bond has the potential to open up an international investor base, firms with weaker balance sheets may find it difficult to use. Too much reliance on external debt, exacerbated by the issue of Bangla Bonds, apart from the non-concessional external borrowing for the mega projects, can lead to serious pressure down the road on the balance of payments and the sovereign ratings.
Too much success with the issuance of this bond can also be problem as it will lead to appreciation of the taka, thus discouraging exports, remittances and dent the competitiveness of several Bangladeshi industries.
The author is an economist.
