The National Bank of Moldova (BNM) and the government of Moldova have signed a memorandum of understanding on the conversion of emergency aid extended to three troubled banks into government bonds. The banks received MDL13.6bn (€610mn) of aid - equivalent to 11% of Moldova’s GDP - from the central bank with state guarantees in 2014 and 2015.

The bond issue would nearly triple the country’s current domestic debt (5.9% of GDP) and push total public debt to some 37% of GDP. The country’s external debt, some 20% of GDP, is financed mainly from international financial institutions at preferential interest rates of around 1%.

The memorandum was not announced by the authorities when it was signed on March 9, but it was disclosed by consultancy Deloitte in its audit report on the 2015 financial situation of the central bank. The government announced plans to issue bonds to finance the emergency loans extended to the troubled banks last October, but it did not comment at that time on specific details.  

Liquidation procedures have since been launched at the three banks - Banca de Economii, Banca Sociala and Unibank.

Notably, the memorandum was signed the same day as the legal expert commission of Moldova’s parliament endorsed the candidacy of Sergiu Cioclea for central bank governor. Two days later, lawmakers appointed Cioclea as governor.

According to the provisions of the memorandum, the securities will be issued by the ministry of finance at nominal value, bearing a fixed interest rate and provided to the BNM on April 1 or another date agreed between the parties. The amount will be equivalent to the outstanding emergency loans, with an effective interest rate of 5%. As of March 25, the outstanding balance of the emergency loans amounted to MDL13.6bn.

If the conversion is made under the terms set out in the memorandum - 5% interest paid by the government and a 20 to 25 year maturity for the bonds - this would put pressure on both the government’s budget and the central bank’s resources.

The government would have to pay some 0.6% of GDP in interest on the bonds in the first year, not counting the principal payments. Assuming a constant amount of bonds is bought back during the 20 to 25 year period, the cost of financing would hit some 1%-1.2% of GDP in the first year and gradually decrease afterwards. Assuming constant payment over a period of 20 years, the government would have to pay MDL1.09bn per year – which is 0.82% of last year’s GDP.

The cost might be proportionally reduced if the authorities manage to recover some of the money siphoned off from the three banks. Investigation firm Kroll said it has identified transactions worth $350mn directly linked to the fraud, a central bank report on the progress in the investigations dated March 25 showed. However, it is not clear whether any of the money will be recovered.

The settlement could complicate the country’s negotiations with the International Monetary Fund, which has reportedly recommended a more market-oriented arrangement.

This could in principle be done by issuing government bonds to investors, on which the government would pay the market interest rate. In January and February, Moldova’s government paid an average interest rate of 15.4% on its domestic debt. Such interest rates would triple the interest paid this year to 1.8% of GDP. Even if the government makes no principal payment, this would put major pressure on the budget. The government has already frozen investments and cut public acquisitions to a minimum.

The Treasury currently issues short and medium-term bills and bonds, and it is unclear what yield should it accept in a massive auction of a MDL13.6bn 20 to 25 year bond. The 15.4% interest paid in February was calculated based on the total interest and the stock of domestic debt. However, local daily Wall Street disclosed that the banks refused a government offer to buy the bonds at the 5% interest rate sketched under the memorandum.