August 12, 2011

Weighing donors versus bonds


The global focus on Standard and Poor’s downgrade of United States debt inevitably brought attention to the Kingdom’s credit ratings. At the same time, one wondered why the Cambodian government had yet to leverage those ratings to issue debt of its own.

Cambodia’s funding needs far outpace its generated revenues, making extensive donor support essential for development. However, there are steps that could be taken to move the country toward greater financial independence, even if this is a long-term goal.

No doubt issuing bonds is a small first step, but doing so sets in motion a virtuous circle of events that could benefit the entire economy.

“Once the government can prove itself as a credit-worthy borrower, these kinds of standards should spill over into the corporate sector and banking sector. So money doesn’t just pour into government bonds but also into the real economy,” said Christian DeGuzman, an analyst at Moody’s Investors Service in Singapore, this week.

He pointed to Vietnam in the 1990s, when the country adopted the transparency needed to build investor confidence. Admittedly, Vietnam still has a long way to go, but growth there has skyrocketed nonetheless. Bond issuance carries with it that transparency and its positive effects.

China went through a similar process, albeit on a much larger scale, restructuring its economy to capitalist from communist. And tiny Singapore now boasts a thriving economy and a AAA rating from S&P.

Of course, there are dangers inherent in issuing bonds for a developing country such as Cambodia. DeGuzman again highlighted Vietnam in this respect, saying the government there sold debt in order to fund state-owned enterprises, one of which, Vinashin, almost collapsed as it missed debt payments to international lenders. Now there’s doubt as to whether Vietnam will honour those debt commitments when they come due. Also, one could argue the government’s decision to not sell debt on the international markets spared the country even greater trouble when the global financial crisis hit.

But Standard and Poor’s analyst Agost Benard said Cambodia’s bonds most likely could have withstood the hit. He reckoned the country would have issued a relatively small amount, maybe US$500 million worth, to investors seeking their high yields, rarity and novelty. As a result, the Kingdom should have had a greater ability to service that debt.

“I don’t think that would have had an effect on Cambodia at all,” he said of the downturn’s potential impact on the Kingdom’s bonds.

Still, Benard also saw potential threats in the Kingdom overextending itself by taking on too much debt, as well as a drop in the riel-US dollar exchange rate.

Cambodia’s bonds would be dollar-denominated, as he said there would be little international demand for riel-based issues. Therefore, a drop in the exchange rate would leave the Kingdom vulnerable because it lacks the ability to quickly generate new dollars if needed when those bonds mature.

Despite these challenges, Cambodia should push forward with bond issuances nonetheless.

Cyn-Young Park, principal economist at the Asian Development Bank’s Office of Regional Economic Integration, agrees. She said that while foreign aid is still very much needed, the country’s long-term goal should be to wean itself off that funding.

“The country needs to work on establishing more self-sustainable funding sources, including better tax collection and more efficient domestic resource mobilisation.”

She added the idea of developing local currency bond markets to those suggestions as well, among other initiatives. Doing so would help the government reduce reliance on external funding for its fiscal spending, she said.

The importance of reducing that external funding is integral to Cambodia’s economic development. While no one can fault the government for accepting donor money at interest rates far below a potential bond yield, the practice could eventually run counter to the goal of financial independence.

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