Moses 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.
Almost 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.
It 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.
Technically 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.