We need a vibrant bond market

09 Aug, 2019 - 00:08 0 Views
We need a vibrant bond market

eBusiness Weekly

Alfred M. Mthimkhulu

In legendary tales of banking dynasties, the Barings and the Rothschilds feature prominently. A few well-researched books on them enlighten us on their intricate dealings with governments and industrialists. That they accelerated the pace of infrastructure development and industrialisation in Europe is incontestable as is their role in facilitating resurgence of fragile nations. A few moments we spend reflecting on some of their transactions are moments well spent especially in our circumstances.

We learn from the legends that the very same bankers also helped finance fatal wars with as much zeal as they financed post-war reconstructions. At the centre of all their activities we find bonds. Bonds are “I-owe-you” certificates issued by, say, an entity such as a government promising that it will repay the value written on the certificate (e.g. $100) in say 5 years and will be paying interest periodically to whoever holds that certificate.

Let us reflect a bit on bonds in the context of struggling economies.

In November 1799, as the new century dawned, Napoleon Bonaparte assumed office as the First Consul of France.

In 1804, he became Emperor, a significant step in his quest to dominate Europe. But by then, France was already at war with England and most of Europe would be roped-in.

Napoleon had the largest army Europe had ever seen. Its size and its geographical spread stretched the capacity of the Allies. Indeed, in England, the Duke of Wellington who would defeat Napoleon in June 1815 complained incessantly to Treasury that he was severely constrained in what he could do because cash, that indispensable lubricant, was not reaching his men in the trenches.

It was on this challenge that Nathan Rothschilds was tasked by the English government in January 1814 “in the most secret and confidential manner to collect in Germany, France, and Holland the largest quantity of French gold and silver coins not exceeding £600 000, which he may be able to procure within two months”.

Nathan leveraged on each of his four brothers posted in Amsterdam, Paris, Frankfurt and Berlin to mop-up gold and ship it to London.

From there, he dispatched the gold to the dispersed army. Underpinning all this would be a bond issue with terms structured by Nathan. Proceeds from the issues would then be handed to Nathan to head off for the gold-buying spree. In all this, he helped secure victory in 1815.

In the peace settlements terms, France was to pay an immediate 50 million francs and 700 million francs over 5 years. But France had no money. Treasury tried the usual: cut spending and raised taxes. It didn’t work. They needed a surplus of at least 170 million francs annually to cover war reparations.

In 1816-17, France had a deficit of 300 million francs financed by short term debt. It was definitely not working. Enter the Barings brothers.

In 1817 Barings issued three tranches of bonds to raise about 300 million francs. Because France was in such a precarious state, bonds with a face value of 100 francs were issued for as low as 52,5 and a high of 61,5. While the discount from 100 tells of poor creditworthiness, it can attract some investors since the price could go up to 100 or even more.

A Barings 1818 French bond flotations illustrates the importance of the secondary market for bonds. The 1818 bond was almost ten times oversubscribed. As a result, the issue price of 66,5 was pushed by speculators to 80. Government was rightfully not amused by all this. It meant that they had given away money: selling at 66,5 what could have been sold at 80. We must not forget that the issuing government, France, was in financial doldrums.

But, thanks to the transparency of bond prices in the secondary market it was clear that confidence in the government and its finances was improving.

Bond prices are thus a barometer of investors’ perceptions on a country without which we can only speculate on progress being made on matters such as confidence and trust building.

Outwitted by the Barings in France, the Rothschilds focused on Prussia, Austria and numerous German states — all struggling economies. The Prussian bond issue of 1818 was particularly intriguing in that instead of being in the Prussian local currency, it was in pounds and paid interest biannually in London.

This was attractive to English investor. It eliminated currency risk for them. The Rothschilds further demanded that the Prussian King needed to convene and get approval for bond flotations from the house of assembly before bankers could proceed. Just like that, bankers had improved in-country debt disclosures and accountability.

There is a fallacy most of us in Africa parrot without much thought. The fallacy is that Africa is too much debt. But note this: in 1816, France’s debt to national income ratio was 10 percent thanks to war-era inflation while victorious England’s was 200 percent. Struggling nations need debt. Even corporate finance experts tell us that a company with no debt is likely to be making less than what it can for its shareholders because debt has a fixed cost — all that is required is ensuring that funds are properly invested and managed.

A bond market is a must-have for a poor country as was indeed affirmed by James Rothschild’s letter to Nathan in December 1815: “You are certainly right that there is much to be earned from a government which has no money. But you have to take risks”. And so does the country. May the investment bankers in Africa please                                                            rise.

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