Holding out for sovereign bonds as finances tighten

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Government intervention programmes including food provisions during lockdowns are pushing up expenditures like never before. Hean Rangsey

Cambodia’s plan to issue sovereign bonds has been a long-drawn-out process. With only the law but no indication of a timeframe, experts can only speculate on what to expect when the bonds make a debut

The push for government debt securities in Cambodia to prop up state coffers is likely intensifying in the background as revenue collection eases, forcing increased external borrowings and more tappings of the savings via domestic deposit drawdowns.

Added to this, total debt made up mostly of external borrowings, has expanded, with loans heaving up to $2.02 billion last year from $1.3 billion in 2019, bringing debt-to-gross domestic product (GDP) ratio to 34.2 per cent of GDP.

About $8.8 billion in outstanding loan was recorded as at end-December, 2020 and is set to hit $9.6 billion this year, Ministry of Economy and Finance’s public statistical debt bulletin stated.

Granted, Cambodia’s debt distress remains low but as public debt and budget pressures persist, external borrowing and drawdown of the government’s current savings increase, more time will be required before fiscal discipline can be restored, the World Bank said.

According to the Ministry of Economy and Finance, the plan to issue sovereign bonds is in process, as indicated by spokesman Meas Soksensan, but he could not offer an issuance timeline nor details of the securities.

For nearly five years, the government has been exploring the issuance of debt securities to raise cash flows, finally passing the Law on Securities 2020 last December.

Over the last month, Prime Minister Hun Sen has been strenuously assuring Cambodians that the government is not heading towards bankruptcy, while contending that GDP growth for 2021 has been revised downward to 2.5 per cent from four per cent previously.

Apparently, talks are that Cambodia’s finances might be constrained as a result of the Covid-19 government intervention programme, seeing that government revenue had dropped over the year.

Last year, $1.16 billion was set aside for fiscal stimulus while $1.15 billion has been allocated this year, based on the 2021 budget law.

Owing to increased expenditure, fiscal deficit is projected to widen to 3.7 per cent of GDP this year, the World Bank said in its June publication, adding that government debt, made up mostly of external borrowings, could rise to 35.2 per cent of GDP this year.

To finance this deficit, foreign funds up to 4.2 per cent of GDP would be sought along with domestic financing-drawdown of government deposits of 0.3 per cent of GDP, while debt amortisation accounts for 1.2 per cent of GDP.

It said although government deposits remained solid at around 24 per cent or 24.9 trillion riel ($6.1 billion) at the end of 2020, the deposits have ‘eased significantly’.

“Deposits grew at 4.6 per cent year-on-year in 2020, down from 47.2 per cent in 2019 due to a slowdown in revenue collection and thus a deceleration of government savings accumulation,” the World Bank noted.

Currently, tax revenue, which lines the state coffers, represents about 20 per cent of GDP and is expected to increase as collection improves, UN Development Programme (UNDP) said.

But as Cambodia prepares for its graduation from least developed country (LDC) status within this decade, broadening its domestic lending instruments is pertinent, owing to shrinking concessional loans.

While it opens up a domestic debt market with the issuance Treasury bills and bonds, this fixed-interest instrument will help deepen the capital market.

As of now, a corporate bond market has been established with six issuers, predominantly financial institutions, listed on the Cambodia Securities Exchange.

Alluding that it should have happened earlier, Anthony Galliano, CEO of Cambodian Investment Management Co Ltd, described Cambodia’s debut in the sovereign bond markets as ‘belated’, citing how low-income developing nations such as Côte d’Ivoire, Ethiopia, Ghana, Kenya, Senegal, Rwanda and Bolivia have already issued bonds.

“Cambodia, already reaching lower middle-income status in 2015, and accelerating to upper middle-income status, certainly has comparable if not better credentials.

“Even tiny Bhutan recently made history by successfully issuing its first sovereign bond, despite a very small population size of 763,000 and GDP of just $2.4 billion, compared to Cambodia’s population of 16.5 million and GDP of $25.95 billion,” he said.

Nevertheless, he remarked, sovereign bond issuance would be a ‘monumental step’ for the development of the Kingdom’s capital markets, which presently has a marginal equity and corporate debt market, with miniscule retail participation.

Credit rating bearings

One of the factors to consider is Cambodia’s sovereign credit rating which would have an influence on the yield and term.

In recent years, Moody’s Investors Service Inc has maintained a B2 rating on Cambodia with a stable outlook and GDP growth projection of 2.9 per cent for 2021.

Interestingly, it is the only global credit rating agency that prescribes a sovereign rating on Cambodia, following S&P Global Inc’s assumed cessation of coverage on Cambodia – its last dating back to 2013 when it afforded a B/B rating.

Anushka Shah, Moody’s sovereign risk group vice president and senior analyst, said issuing bonds, whether domestic or foreign, would add to Cambodia’s overall debt burden.

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The credit implications would depend on the quantum of issuance and the terms of issuance, with the latter determining the implications on Cambodia’s debt affordability.

“However, it’s worth noting that Cambodia’s debt burden – at 34.4 per cent of GDP in 2020 by Moody’s estimate – is substantially below the median for B-rated sovereigns, which stands at 58.3 per cent, and given that a substantial portion of borrowing is on concessional terms, debt servicing costs are relatively low,” she told The Post via email.

Moody’s B2 rating for Cambodia’s sovereign credit incorporates a number of aspects, including economic strength, institutional and governance strength, fiscal strength, and susceptibility to event risk.

“While obligations with a B rating are considered speculative, Cambodia’s sovereign credit rating is comparable to its neighbouring countries such as Indonesia (Baa2), Malaysia (A3), Philippines (Baa2), Thailand (Baa1), and Vietnam (Ba3),” said UNDP acting resident representative Sonali Dayaratne.

But looking at Cambodia’s rating which is on par with countries like Costa Rica, Egypt and Kenya, the nation’s sovereign debt would be considered high risk, speculative, and facing major uncertainties.

“The rating is three notches below investment grade for Standard and Poor’s, its investment grade being BBB-, and thus investors will expect a higher yield and a short-term tenor,” said Galliano.

As such, he opined, the current market environment is not ideal for low-income countries as the pandemic has caused a decrease in investor interest, sharp volatility in capital flows, and deterioration in borrowing conditions, as there has been a trend to flight to safety.

However, Galliano mentioned that low to negative yields for investment grade sovereign bonds, should make the bonds attractive to speculative investors.

Separately, Sim Dara, director of Yuanta Securities (Cambodia) Plc, said while sovereign ratings often influence the nature of sovereign bonds, it depends on who offers this perspective.

“If it is from foreign investors, Cambodian government bonds will likely be considered as having a sub-investment grade rating, meaning high-risk products [as per] Moody’s sovereign rating of B2. [But] the rating is not going to be of significant importance from the perspective of local investors whose business is exposed to Cambodia’s country risk,” he said via text.

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Dara, whose firm is the underwriter for Acleda Bank Plc, Cambodia’s largest initial public offering, as well as LOLC (Cambodia) Plc and Phnom Penh Commercial Bank Plc’s FX-indexed corporate bonds, said for locally incorporated entity, the investment in government bonds will be likely considered as ‘riskless investment’.

“For example, if a local bank makes an investment in Cambodian government bonds, the bank [might] be allowed to assign a risk weight of zero to the bonds in the calculation of its risk-weighted assets in order to derive its solvency ratio,” he explained.

High yields?

In 2016, Adisorn Singhsacha whose firm Twin Pine Group Co Ltd advised the Laotian government on cross-border bond issuance, recommended that Cambodia could look at regional capital markets, like Thailand as a launch pad for its sovereign bonds internationally.

In the present day, Singhsacha, who is founder and CEO of the Thai-based financial advisory company, said in international markets, Cambodia’s government bonds would be considered `high yield’ because of its credit rating but if they are projected on Thai rating scales, the bonds would be considered `investment grade’ instead.

Based on his calculation, he viewed that indicative yield for a five-year maturity term, if launched in an international market, for instance Singapore, would be around 6.5 to 7.5 per cent per annum whereas a launch in the Thai capital market would possess an indicative five-year yield-to-maturity of about five per cent.

To be sure, the yield range is hypothetical, seeing that there is no known issuance date. However, given the nature of the bonds, determination of bond yields would depend on several factors, including market supply and demand for the bonds and the macroeconomic condition at the time of issuance.

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Dara said investors might want to compare the yield from government bonds with return from other alternative investments such as the term deposits with a major local commercial bank, which can also be deemed as riskless investment from local investors’ perspective.

In Cambodia, where there is no money market and liquid bond market to provide a benchmark, deposit rates at major local banks can be relevant indicators.

“To get an idea of the Cambodian government bond yield, we can also refer to the already-issued Credit Guarantee and Investment Facility [CGIF]-guaranteed bonds. The three-year CGIF-guaranteed riel-denominated bonds issued by Prasac Microfinance Institution Plc have a yield of 7.5 per cent per annum.

“If we can assume the spread between CGIF and Cambodian government of 50 basis points to 100 basis points, we can somehow get the estimates of the government bond yield from 6.5 per cent to seven per cent for the three-year riel-denominated bonds,” Dara shared.

However, he noted that the bonds that he referred to were not actively traded, and therefore the historical yield does not really reflect the current market situation.

Using a similar analogy, Galliano said based on the current credit rating, and historical yields in the corporate bond market, he expected a yield range of seven to 10 per cent depending on its maturity term.

“Short-term bonds would obviously have lower yields and longer-term higher, with expectations of a normal to flattish yield curve,” he said.

De-dollarising the economy

Going forward, Moody’s Investors Service’s Shah said issuing bonds in the domestic market would support the diversification of Cambodia’s funding base, which is currently almost entirely denominated in foreign currency.

“It would be a step towards building a domestic yield curve. If successful, deeper domestic markets would aid overall policymakers’ moves towards de-dollarisation,” she said.

The move to de-dollarise the economy has been a long-standing effort by the central bank, thus the bond issuance in local currency could boost its liquidity in the market.

Depending on the terms associated with the bonds, they might be an attractive investment avenue for domestic investors to park their savings in local currency.

“For both foreign and domestic investors, bonds would be a channel to invest in the Cambodian macro story. The credit risks associated with these bonds would be closely tied with that of the sovereign,” Shah said.

For Singhsacha, the size of the fund to be raised would need to be determined and if the domestic market can fully participate.

“Prior to going to international markets, regional markets, such as Thailand can be an attractive funding hub, given [its] lower risk premium and ample liquidity. Additionally, Thai baht can be swapped with US dollar,” he said.

But first, investors should be clear about their own risk appetite by undertaking a self-assessment of their risk threshold and use it as a basis for their investment strategy, said Dayaratne of UNDP.

Second, investors could consider the date of expected return and the duration up to which they expect to hold their investment.

Unlike stocks which have an investment horizon that can be indefinite, bonds are issued with a maturity date known before bond investment decisions are made, so investors should choose a maturity period they are comfortable with.

“Finally, investors usually evaluate the bond issuer, in this case the Cambodian government, as anyone else they would be willing to give a loan to. Investors might therefore assess Cambodia’s ability to pay according to its economic and fiscal strengths, as well as its susceptibility to risk,” she said.