CARELESS WORDS CAN SINK US:
This has been a lesson from monitoring the performance of the Euro Bond this far.
IN the past couple of weeks, there has been a flurry of articles written about the performance of the Euro bonds that is worthy of discussions, although these discussions have mostly been reported speech devoid of the causal effects analysis. And so this article attempts to address this.
In 2017, there were various articles on the Zambian debt position and perhaps culminating into one online edition about the Zambian debt position from a widely circulated online London outfit, which seemed to exaggerate the country’s debt position beyond the official position of the Ministry of Finance. This article brought out significant adverse publicity on the country’s debt position and began an adverse discourse that is still being felt to date.
In some circles, our debt position was insurmountable and that we were on our way to default. Time permitting. The default story spiralled on overkill and it was being picked up everywhere, but most of all, by the holders of our bonds. The fire sale built on fear, had to start.
In April 2018, the Finance Minister Margaret Mwanakatwe felt it was necessary to issue a statement dispelling the assertions that the Zambian government was hiding the true extent of the country’s debt stock and spelled out the external and domestic debt positions.
The minister also encouraged those who felt that the debt stock has been under reported to submit verified and audited information to the Ministry of Finance. Further, the Ministry of Finance decided to periodically provide a quarterly update on the debt stock levels and performance.
Not long after, on 21 May 2018, Bloomberg published an article “The Pain's Getting Worse for Zambia as Eurobond Yields Hit 10%” that the Yields on the country’s 2027 Eurobonds have risen to 10 percent for the first time in almost 18 months exacerbating the pain for bond holders, who were having losses of 11 percent in 2018.
The article also added that Zambia’s dollar securities were the worst-performing in the Bloomberg Barclays Emerging Markets USD Sovereign Bond Index. This is an Index of around 70 countries.
In August 2018, Ms Mwanakatwe was back in the news, in a new heightened role to change this default narrative, and revealed that Government had set aside US$10 million in a sinking fund which would go towards offsetting the US$750m Euro bond scheduled for 2022 and also noted that she would soon be travelling to China to engage the government on debt restructuring. Thus in January 2019, it was not surprising that Bloomberg reported on 28 January 2019 that Zambia’s Eurobonds were proving a great trade for investors who like extreme outcomes, in an article titled “Zambia Finally Gets Some Zoom as its Eurobond Returns Top 10%”.
The article stated, although with a suspect teased reference to Venezuela, that the bond had swung from the worst- performing sovereign bonds in emerging markets in 2018 to the best-performing so far this year making a total return of 10.3 percent since the end of December 2018, more than any of the other 75 nations in the Bloomberg Barclays Emerging Markets USD Sovereign Bond Index.”
So what are the lessons? There are three factors that are important for Euro bonds or any other bonds, viz;
• The Business environmental risk profile
• The Nominal Interest rate return in the particular economic environment and in this case, the Euro Zone
• The Perception of the financial health of the issuing country or simply issuer
The first two tend to mostly influence the level at which the coupon rate will be priced and how the financial instrument will be structured, however the 3rd point is critical to the acceptance and performance in terms of the value of the bond. The bond’s value is measured in terms of yields. The bond yield is the profit an investor makes on a bond. In simple terms, when an investors buys bonds, in essence they have lent money and in return they expect to receive interest on bonds until the bond matures and to be repaid the face value of bonds when the bond reaches maturity.
Given this scenario, the value of the bonds must be equal or be close to the face value of the bond, because the bargain for those who buy bonds is to get the income streams from the interest returns over the term of bond, rather than the change in the market value (Otherwise, they would be trading in stocks).
However, when there is a fear of a potential default, the resale value of the bonds reduces causing the yield to increase signalling that the risk of an underlying security has increased.
In other words, when new investors buy the bond from the market, they are only willing to buy at a significantly discounted price. Put another way, when the yield is high, the credit risk is high. Said differently, when there is a risk of defhault, the buyer of the bond before maturity, can only accept it at a significant discount to the face value.
So in the case of Zambia’s Euro Bonds, when any person, particularly, prominent Zambian personalities, speak negatively about our debt position, those persons inadvertently encourage a certain perception to other stakeholders about the risk profile of the bonds.
And depending on their status, the perception is that they might well be right, and therefore the bonds will re-price to account for this new information about risk.
In other words, the risk of default is priced into the bond as new investors become unwilling to buy the bond unless at wide discount to face value.
So what happened in January 2019 about the value of our Euro bond? Simply that we had managed as a country to wade through the various misinformation that had been going on, by managing to explain that we are unlikely to default, that the country will pay down the debt when due.
The Ministry of Finance has done a good job in that regard. As such, what happens when Investors started to feel comfortable, that they will be paid their debt in full, on maturity, the new bond holders became unwilling to abandon the bond, preferring to hold to maturity or until some other more lucrative stock shows up and because of similar set of circumstances, the Zambian Euro Bond started to gain value, to trade close to the face value or in financial terms, the yield had narrowed.
So when prominent individuals in their inventiveness, speak negatively about the economic performance of this country, they in the process also heighten the country risk. In our case, a look at the performance of the Euro Bond shows this very clearly. This is, in a nutshell also what happens to foreign direct investment into Zambia and consequently the value the dollar relative to Kwacha, among other cause effects. In other words, like in any home, careless words can sink us.
About the author: Kelvin Chungu is a Partner at Nolands Advisory Services Limited. He is contactable on kelvinc@nolands.co.zm or +260976-377484.