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20hrnuvMoses has reached the mountain, finally! It took a $3 billion political crisis to make it happen, but it has happened nonetheless. I am of course talking about the Government’s decision to finance the Padma Bridge with local funds.

It’s not difficult to understand why donor funding seemed so attractive to begin with. It’s pretty hard to say no to concessionary interest rates as low as 0.75%.

Notwithstanding the whole fiasco around World Bank funding for this project, let’s be clear about something – we fund Padma Bridge-sized projects every year.

The table below shows the Government’s revenue and expenditure figures from this year’s budget, expressed as a percentage of GDP. It basically means that in the last fiscal year (2010 11), the Government spent approximately TK37,000 crores under the Annual Development Program (ADP) budget.

nofel  newAlmost all of it was deficit-financed, meaning the Government borrowed money either directly from the banking sector or by selling bonds to the public to pay for it. And perhaps most importantly, about 90% of the ADP budget was sourced domestically, while the rest came in the form of foreign aid.

The Government has already announced that it will cost a total of Tk 23,000 crores in four years to build the Padma Bridge, with the cost this fiscal year (2012-13) likely to be about Tk 3,200 crores. That’s 6% of this year’s ADP budget!

If the Padma Bridge is such an important priority, who’s stopping us from diverting 6% of this year’s ADP budget to start this project? The simple fact of the matter is – we can pay for the entire cost of the Padma Bridge from the ADP budget alone.

But the Government is not too keen on doing that, and rightly so. There are better ways of financing a bridge, ways which can fulfil other important objectives and lead to wider benefits. A bit like knocking down two birds with one stone.

The Government will be better served if it raised the Tk 23,000 crores needed by issuing bonds to local investors, and allowed those bonds to be traded in the secondary market. This would help create a more vibrant and liquid bond market, which is something we don’t have but need desperately.

Sheikh HasinaIt will allow investors to gain exposure to a new asset class, leading to greater portfolio diversification and enabling financial market deepening, which is very important for sustaining future economic growth.

So will it work? Can the Government raise Tk 23,000 crores from local investors? There is absolutely no reason to think why it can’t.

We know that there are approximately 20-30 lakh active stock market investors in Bangladesh. Taking the lower figure of 20 lakh, each stock market investor would need to buy a little more than Tk 1 lakh worth of government bonds to raise Tk 23,000 crores over a period of four years.

That comes to a Tk 25,000 investment every year!

Are we really prepared to say that investors aren’t ready to invest Tk 25,000 a year for four years to build the Padma Bridge? My guess is that a lot more than 20 lakh people would be happy to jump on board, depending on the interest rate the Government offered on these Padma bonds.

That brings us to the most critical question – what interest rate would the Government have to pay? Believe it or not, the Government could borrow at an interest rate of zero.

That’s right, I said Z -E-R-O!

Sounds crazy I know, but it’s possible, and it happens all the time in international financial markets. Bonds that pay no interest are known as zero-coupon bonds. Zero-coupon bonds usually provide a lump sum return to investors at the end of the term.

1341213973_02jul12-padma.pgTechnically speaking, although the Government would pay no interest on an annual basis, the lump sum return it would have to offer when the bond matures is a form of interest cost. However, it is possible for the Government to avoid that as well.

It can do that by converting these zero-coupon bonds into shares in a holding company. Let’s call this holding company the Padma Bridge Company Ltd. It will be listed on the stock exchange, and will pay dividends on its shares with the profit it makes from collecting toll on the Padma Bridge.

In other words, the original bondholders become shareholders after a certain period of time. These types of financial securities that start out as bonds but then become shares are simply known as convertible bonds.

The advantage of using such instruments is that it would enable the Government to arrange the financing in a lump sum in the form of debt without any upfront costs, while allowing the cash flow generated from the project through toll collections to flow to the investors as returns on equity. That’s how public-private partnership or PPP projects essentially work.

The most obvious question it raises is – would it work? Why on earth would anyone want convertible bonds that wouldn’t provide any returns until after four years?

The answer is pretty straightforward actually. You would want them for the same reason you save your money in a fixed deposit account. People often want to or need to save for the long-term.

Zero-coupon convertible bonds in many ways function like 4-year fixed deposit savings accounts, i.e. you have to wait four years before you can access your returns. However, there is a major difference between zero-coupon convertible bonds and fixed deposit savings; with fixed deposit savings, your return is – as the name obviously suggests – fixed. With convertible bonds, because they convert into shares, there is no limit to the profit you can make.

Profits could be 10% or a 100% if the share price keeps rising. But
investors could also end up making a loss if the share price falls below the original bond price.

It is possible that long-term uncertainty over returns on these convertible bonds could discourage people from investing in them. But there are a number of things the Government could do to address those concerns.

One possibility involves ‘granting’ put options to the bondholders at a strike price that is equal to the original price of the convertible bond, thereby guaranteeing that no investor will make a loss.

Put options are financial securities that enable option-holders to sell shares at a price (known as the strike price) that is higher than the market price. For example, let’s assume that the original price of the convertible bond and the strike price of the put option are both set to Tk 100. After the bonds are converted into shares, if the share price falls to Tk 90, put option holders will be able to sell their shares back to the Government at the Tk 100 strike price, thereby breaking even rather than making a loss.

Adding this kind of a derivative structure to the financing deal would provide downside protection (meaning protection against losses) to investors. On the other hand, there would be no limit on the return investors could earn if the share price kept rising after conversion.

Designing convertible bonds with downside protection would also allow the Government to target low-income groups. The Government’s aim to raise funding from local investors shouldn’t just be limited to urbanised middle to high income folks who invest in the share market or have large savings in fixed deposit accounts.

Low income individuals like day-labourers and rickshaw-pullers should also be provided the opportunity to invest in the Padma Bridge. It will enable them to acquire assets and accumulate wealth faster, an important stepping stone on the road to prosperity.

You might think that’s a fantasy; how can rickshaw-pullers possibly afford to buy government bonds? In reality, that is not very hard to ensure.

The Government can achieve that social objective by issuing zero-coupon convertible bonds that have a low face value, Tk 10 for example. But providing downside protection is important because low-income individuals can least afford to incur losses.

In any case, the possibilities are endless as far as how the Government goes about solving this mess they have created.

But what a beautiful mess to be in! Anything that requires us to think and innovate our way out of trouble is a good day in the history of our development.

There is no other way to overcome the poverty of the mind.

Nofel Wahid is an applied economist.

28 Responses to “The World Bank’s cancellation is a blessing in disguise”

  1. BD Pride

    It is good to see that not all are quitters and avenues of solution are presented by defferent quarters. I would like to point out a bit different issue here, one i havent seen raised but would like to see detailed. It is the political failure of AL government on Padma Bridge. Yes, WB is a political force that uses money to gain political leverage to get their policies, they see fit, implemented in countries. AL should have asked the minister(s) involved to resign as soon as the issue was raised. They could have come out clean and announce the reason for resignation saying, “I resign because i am not corrupt and i do not want my country to fall behind to suffer because of these false accusations. Once investigation ends I will be vindicated and people will see the truth.” I think most people would have admired that. WB would, then, needed to find some other way to screw us. This was too easy for them. While I do believe that there were some schemes of corruption probably in hatchery, but that’s Bangladesh for you and me. I would like it if someone plays out these scenarios in detail. Personally I think this was the biggest political mistake AL has made.

  2. Golam Arshad

    It is a classic case of “Contrite Distraction”. Good luck Madam Prime Minister. Like Play to the tune of the Devil, and yield to the Act of God…!!!

  3. Golam Arshad

    Vouching a Machiavellian syndrome of :”ontrite distraction”.. Buy time first, then tangle to yield, be it the name of the game. Good luck Madam Prime Minister!

  4. nargish

    Nothing will ever happen with all the buffons holding political positions. I am sure most of them have already started licking like their lala just hearing these. This would be a killing money making idea.
    Finally some one bought into their elaborate game. Not a dime from me.

  5. Ahmed Nasir

    This decision the govt could take before the collapse of STOCK MARKET…Now those who are affected… they don’t have money in their pocket… why do we take important decisions so late?

  6. Sandip Sureka

    It’s not only C-R-A-Z-Y but felt like reading a fairytale.

    Firstly, the project size is approximately 10% of market capital of DSE. Is it possible to collect that much of money from the capital market given the current situation?

    Secondly, an investor will buy these instruments with low expected return if they are fool or they are made fool. No matter whatever instrument is used, investors will be attracted to those instruments only if expected return from these instruments is at least as much of fixed deposit interest rate (possibly with a premium for risk factor). If the government afford to offer such high return, why can’t we borrow from international financial market?

  7. Mahfooz

    I must say, I did not pay much attention to this ‘inspired and creative’ financing write-up, specially the last part. This is because the most important aspect of the financing package was left out for reasons known best to the author.

    The author talks at length on funding and repayment of the borrowed money, which is fine and I have no quarrel with that!

    The problem is that full 80-90% of the fund required for the project is in foreign exchange. To raise $2.1 billion dollars from anywhere is a task beset with unknown pitfalls, such as, in short:

    1. From own reserve: No developing country spends its FE reserve, including India and China on long term development projects. It is sound practice by all Central Banks (as it is a firm and inviolable policy of RB of India) to keep the reserve to pay for import bills. Export earning is a changing quantum, whereas import bills are not: for Bangladesh the imports are rising all the time. No one knows what will be our export situation next year or the next but one thing is certain, our import bills are always rising pressurizing the FE Reserve. It is safe to keep at least 6 months reserve for imports. We have reserves of about 3 months import bills at this time. We are already hard pressed to pay for import bills specially after paying for high cost fuel for the Quick Rental power generation trap. Only last year the BGD borrowed $1 billion from IMF to assist balance of payment deficits. Meantime, exchange rate deteriorated from Tk 71 to TK 86 in a few weeks. We had to swallow the bitter pill of reducing subsidies and increasing the electricity rate as per IFM prescription, adding to the inflation. How on earth we propose spend our scarce FE on prospects of long term return and there by endanger entire macro economic stability? I would request the author to enlighten us on this thorny issue.

    2. Sovereign bond: With our present international credit rating (below that of Sri Lanka, which borrowed at 8%) the minimum interest rate will be between 8-10%, excluding the cost of floating such a bond. There is absolutely no certainty that such a bond will be promptly subscribed. Even if it is subscribed, what will be quantum of the borrowing and what impact it will have on the economic viability of the project i.e. what will be the toll for a car or truck that will eventually cross the bridge? What will be our repayment schedule for the duration of the bond? Will our export earning cover the cost of principal amount and interest? Such unpleasant questions need to be addressed realistically before we jump into this high cost financing regime.

    3. Funding from NRBs: Most of our remittances come from working people toiling manually in the Middle Eastern countries. They are poorly paid and send money home to repay their debts and to sustain their families. They have little or no fund to invest in long term bonds which they, by and large, hardly understand. There are number of existing bonds in FE for them which are in operation. The response is poor indeed. To expect that these poor people will invest their money in long term bonds is an expectation most likely to be dashed when put in the test of fire in the money market.

    Since it is unlikely that such bonds will be subscribed in any large quantity, the question of interest rate is only a theoretical exercise.

    And the rich and the super rich of Bangladesh who have money in foreign banks (the people in general know who these are, what about them? It is most likely that will NOT (I am sure of this, as will anyone with any sense of reality) part with one dollar of their illegal wealth. (illegal per se, because one has to declare to Bangladesh Bank one’s foreign bank balances. I have no idea what info BB has on the foreign bank accounts of Bangladesh nationals). Their contribution will be by declaration of patriotic fervour and ‘unflinching willingness’ to shed their last drop of blood for the country! But sadly, drops of blood, if at all shed, do not bring dollars, pounds and yens to finance the Padma Bridge!

    4. Management Issues: With the present poor state of management of govt projects (e.g Dhaka-Chittagong highway is a prime example of such a horror), how is one certain that such a mega project will be managed well (i.e. remain corruption free over many years till the bridge is completed ) and will be finished on time and within budget. One fears that if one goes by ANY BDG managed project, surely the cost and time will run over by many times when finally finished. This realistic assessment based on decades of experience and is independent of financing the project.

    There are indeed numerous pitfalls in attempts to finance and manage this project within our own resources, both financial and managerial.

    We shall have to get low cost foreign finance from a, or, any out side sources. India and China with their booming economies and huge FE Reserves are also the two biggest borrowers from the World Bank. (I suspect that their planners invest their own funds at high interest rate in the international money market, at the same time borrow low cost, long terms funds from World Bank! It is a policy worthy of the Gujrati money lenders: earn high rate on your money, and borrow others money at cheaper rate!) If these economic giants of Asia do not fund long terms development projects from their own resources, as a matter of policy, it is a pipe dream that we will be able to do so profitably by some magic.

    There is little value of histrionics in development economics. Nationalistic fervor may win wars (they do not actually, as shown by Germany and Japan in 2nd WW and numerous Arab Israeli wars later), but money does not come from slogans and noble sentiments, unfortunately.

    Let us be realistic and pragmatic.

    Our planners should generate full project profiles considering all factors and taking into consideration international politico-economic considerations, and decide pragmatically and realistically the cost-benefit ratios of multiple options as regards this mega project. [I am afraid, no such exercise is likely to be done, if one knows the way our bureaucracy works- appeasing their political masters by being true and faithful ‘yes men’. They know where their own future prosperity lies.]

    One of the options is to wait and see, to let things cool down and then re-evaluate the whole thing in the light of reason and not be swayed by emotion and political slogans. We can wait for a while before taking measured, realistic and useful decision rather than to take hasty but irretrievable steps that may be economically suicidal for this poor country.


    • Mohammad Zaman

      I am not an economist, still I understood the fantasies of Mr. Wahid. Thank you Mahfooz Shahib.

      • Mahfooz

        Let me try and reduce the complex issues into simple terms so that the ‘Owners of the Bridge’ i.e. the people of Bangladesh understand what they are getting or getting into or not getting at all.

        The Padma Bridge is to be built on two basic assumptions, that it will allow us:

        1. To cross the Padma speedily: for people and goods
        2. To pay an economic rate of toll to do so (no higher than the Jamuna Bridge toll rate)

        The bridge if built with funds other than the concessional rate that the WB Contract ensures will cost many times more if at all found from somewhere. There is no second opinion on that. [For the sake of argument, let us say that the management of construction is of global high standard and that of money transparent and corruption free.]

        If so, what will be toll rate?

        If it is higher than what the market can bear, BDG must subsidize the toll rate to make people use it. This is almost a certainty.

        How much is the subsidy which is to paid over and above the high repayment of market rate loans used for its building?

        How will the people pay it, (subsidy on toll in Taka and repayment in foreign currency) because these liabilities are to be paid out of taxes collected from people.

        People of Bangladesh have a right to know these figures.

        The question of finance or how to finance are secondary issues to these fundamental questions.

        Will the authorities answer these simple questions?

        If not, none has a right to mortgage the economic future of Bangladesh against a white elephant that will ultimately reduce us to what Spain and Greece is presently: national bankruptcy.

        Point to note: The Japanese Ambassador declared publicly yesterday that the Padma Bridge if funded from own sources will not be ‘sustainable’. I wonder why he said that? May be Japan has joined the increasing number of international ‘conspirators’!


  8. Ahmed

    I am really interested to know about the author. How did he become an applied economist.

  9. chaman

    Good to read the hypothetical suggestions, but what is the solution to erase corruption from society forever. Any solution ?

      • Ali

        How to instil honesty when the opposite is so blatantly lurking around and omnipresent?

        Well, only through EDUCATION, that is imparted by teachers who are truly educated and get a semi-decent compensation, can we improve the situation..

        And also through some stark examples of fighting corruption.

        Good luck, Bangladesh. Keep trying while the enlightened youth gather steam for change!

  10. S S Anam

    The article is full of ideas, swimming aimlessly like fishes, in a turbulent sea of uncertainty!

  11. Iftekhar Hossain

    কীর্তিনাশা পদ্মা
    পদ্মা নদীর নাইয়া আমি
    গাঙের কুলে বাস
    জন্মাবধি নদি আমার
    করলি সর্বনাশ।
    ভিটা মাটি গ্রাস করলি
    বাস্তুহারার বেশে
    হাড়ি পাতিল তুইলা মাথায়
    ফিরলাম দেশে দেশে।
    সেতু গড়ার খবরে তুই
    গোস্বা করলি নাকি
    নতুন কইরা ভাঙলি কপাল
    যেটুক ছিল বাকি।

    • Tasnim

      I was privileged . I read it earlier. And I had a reply which I sent you but unfortunately I lost it. If I had I would love to post.

  12. sharif

    Definitely it’s a good idea. First of all we have to be mentally strong enough to accept it. The recent scars on share market have baffled us. A country like Bangladesh which can implement a budget of around 2 lac thousand crore with more than 6% growth rate can also be capable to implement it.

  13. kotoajana

    Is that what you really think that lack of innovative ideas led us to all sorts of mess? I hope not.

  14. Shottobadi

    Mr Wahid, even someone like me feels inspired after reading your article… thank you.

  15. arosh ali

    Question: why should anyone be financing corruption infested governments? Is it not clear enough that the WB is refusing to lend on the ground of possible mishandling of the funds with realistic reference of kickback as commission? Are the people fool enough to believe that thieving cannot take place in advance until money change hands? I hope Bangladeshis understand a term called white-collar crime.

    Have we the people become sick forgetting our dishonest records set as nation regardless of which party’s in power?

  16. Golam Arshad

    Be my guest! Welcome call! Why can we! Others could do it!!!

  17. Mohammad Zaman

    Fund is never an issue with our government. A large percentage of our annual development fund can not be used because of poor capacity. And the percentage of fund that is spent get smaller on the way (for paying of percentage for the nefarious).

    The crux of the issue is transparency in implementation that is a rarity in Bangladesh. And the other issue is capacity to spent and technology to build.

    And not the least is the trust by the technology companies to come and work in BD without upfront payment.

    But the article is a good way of looking at a “half full” glass. I do not know much about finance, but the tortuousness of the financial instrument proposed by the author worries me.

    And lastly, the bond has to raise dollar or euro and not taka. Will the proposed instrument be kosher for foreign investors?

    • Nofel

      Hi Orko. I use that term so as not to create the impression that I’m a university academic. The general convention in the economics profession is that ‘economists’ are those who do research at universities, while those who work in industry (e.g. banks) usually call themselves ‘business economists’. I work at a think-tank where my work focuses on policy issues, so I don’t fall into either category.

    • Syed Kayes

      Did you try the Google Search Tools for a satisfactory definition of an applied economist? If not, don’t take the trouble of doing so! Because you may not find one which may satisfy your curiosity! By the by,what has prompted you to ask the question?

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