Gary Kleiman of Kleiman International -
The refugee crisis overwhelming Europe has revealed an east-west split over how to solve it, reflecting cultural as well as budgetary differences between the two halves of Europe. Could “refugee bonds” provide both the commercial and “solidarity” returns to strengthen the European project?
Emerging market frontline states in Central Europe and the Balkans are unaccustomed to hosting large foreign populations and are poorer than their Western neighbours, which means that if anything they expect to receive aid for their own humanitarian needs rather than give it. Some of these countries also run chronic budget deficits, and to bridge them sovereign local and external bond issuance has become routine. Thus governments in Emerging Europe could raise billions through bonds to pay for dealing with the refugee influx. Global fund managers have maintained positive net emerging market debt allocations this year where the proceeds go for infrastructure and social spending, and money for refugee issues could be a natural extension to this.
Before the Syrian and Iraqi exodus to Europe, refugees had reached immediate neighbours Turkey, Jordan and Lebanon, which had absorbed millions and were struggling from the financial strain.
Turkey’s military operations against Islamic State have added to the conflict’s cost; the government claims to have spent $7.6bn coping with more than 2mn refugees. It has largely absorbed the burden out of its own resources, as stock and bond outflows recently hit $5bn with the announcement of new elections portending further political gridlock. The investment-grade sovereign rating is under review and the equity market, down 35% so far this year, is the worst performer in the MSCI core universe behind Greece. Local bond yields are above 10% on creeping double-digit inflation, and economic growth forecasts have been slashed to less than 3%. Remittances from the wider Syrian and Iraqi diaspora will help, but the current account deficit remains 5% of GDP and the primary budget surplus is under pressure from the refugee outlays.
Jordan has depended on a $2bn International Monetary Fund (IMF) programme and $5bn in Gulf Cooperation Council assistance, and the US has guaranteed a $1bn sovereign bond. The last border crossing to Syria was recently closed and tourism has never recovered from the war spillover and earlier Arab Spring uprising. The small country has hosted a refugee Palestinian population for decades in camps administered by a special UN agency and it's calling for a similar international effort for the new arrivals.
Lebanon has long been mired in the intrigues and violence of next door, and already has among the world’s highest public debt burdens at 140% of GDP. Despite a sovereign downgrade and meagre 2% growth, a $2bn external bond placement was successful with a stalwart buyer base of local banks and wealthy individuals abroad. For over a year, infighting between Hezbollah and other political parties has blocked everything from formation of a government to trash collection.
Iraq, with its huge internally displaced population, has announced a $6bn bond plan to tackle the problem and gaping budget deficit, and speculative investors might be tempted by 10%-plus yields.
Greece across the sea from Turkey was the first Emerging European destination to feel the refugee crisis, which has since spread to Hungary, Serbia and elsewhere as gateways to desired resettlement in Germany and other richer EU members.
Hungarian Prime Minister Orban might be trying to outflank the opposition far-right Jobbik party with his xenophobic rhetoric and fence construction, but he has also worked hard to assuage foreign investors holding one-third of local debt so he can pay for the limited numbers he will probably have to accept under the EU quota system despite his tough line. Before the crisis, Hungary’s budget was on track to meet Brussels’ 3% of GDP deficit threshold, and the successful forcing of banks to convert expensive Swiss franc mortgages into forints softened the threat of additional punitive taxes. The stock market through end-August was the top MSCI Index gainer at 25%, and deflation was rolled back that could have raised the cost of public debt at 80%of GDP.
In Serbia, by contrast, the stock market has dropped over 20% this year on the MSCI Frontier Index and foreign investors remain wary of local and external debt, despite progress on reducing fiscal and current account imbalances under a new IMF accord. The benchmark 5% interest rate is Southeast Europe’s steepest as inflation increases with electricity price hikes. State enterprise divestiture that has been promised for years is proceeding slowly, with many banks and “strategic” firms still off limits. Croatia has also received waves of refugee and might soon need to turn to the IMF for help with its cash-strapped finances. Leaders in both countries have clearly stated that with cash crunches they cannot handle the refugee flows and have asked the UN and EU for contingency funds.
Bilateral and multilateral guarantees could enhance refugee bonds from credit-strapped sovereigns, but Hungary, Turkey and others could issue them cleanly as a logical adaptation of existing instruments, combining commercial return with public policy objectives. Such a targeted instrument, to be credible and come at a reasonable cost, would need an independent tracking mechanism for how the proceeds are used, from basic essential services to possible job training, and that feature can draw on the UN refugee agency’s on-the-ground presence.
As Europe scrambles to respond to the crisis it could convene a global working group comprised of government and international organisation representatives, investors and underwriters to design pilot issues for the continent and beyond. Emerging economies will no longer feel under such siege if they can mobilize distinct versions of their own financial market tools to meet the historic challenge.
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