Europe’s Missing Financial Instrument: Refugee Bonds
The Middle East and African refugee crisis overwhelming Europe has revealed an East-West split toward acceptance reflecting cultural as well as budget differences. Emerging market frontline states in Central Europe and the Balkans are unaccustomed to hosting large foreign populations and are poorer than their Western neighbors and can seek EU aid for their own humanitarian needs. They run chronic budget deficits but to bridge them sovereign local and external bond issuance has become routine. Governments in central and Eastern Europe may also be able to raise billions of euros through bonds for the Syrian, Iraqi and Northern and Sub-Saharan Africa influx. Global fund managers have maintained positive net emerging market debt allocations this year where the proceeds go for infrastructure and social spending, and dedicated refugee issues would be a natural extension. “Refugee bonds” could provide both commercial and “solidarity” returns to strengthen the European project, and redress the UN’s traditional donation gap after relying on government and private sector appeals.
Before the Syrian exodus reached the continent immediate neighbors Turkey, Jordan and Lebanon had absorbed millions and struggled to relieve the financial strain. Turkey’s military operations against Islamic State have added to the conflict’s cost; the government claims to have spent $ 7.6 billion for more than two million refugees. Exports to Syria slid to $750 million in the first half after 2014’s $1.8 billion full year total. It has largely absorbed the burden out of its own resources, as stock and bond outflows recently hit $5 billion with the announcement of new elections portending further political gridlock. The investment-grade sovereign rating is under review and the equity market, down 35 percent, is the worst performer in the MSCI core universe behind Greece. Local bond yields are above 10 percent on creeping double digit inflation, and the economic growth forecast was just slashed to less than 3 percent. Remittances from the wider Syrian and Iraqi diaspora will help, but the current account deficit remains 5 percent of GDP and the primary budget surplus is under pressure with refugee outlays.
Jordan has depended on a $2 billion IMF program and $5 billion in Gulf Cooperation Council assistance and the US has guaranteed a $1 billion 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 called for a similar international effort for the fresh arrivals. Lebanon has long been mired in intrigues and violence next door and already has among the world’s highest debt loads at 140 percent of GDP. Despite a sovereign downgrade and meager 2 percent growth, a $2 billion external bond placement was successful with a stalwart buyer base of local banks and wealthy individuals abroad. For over year infighting between Hezbollah and other political parties has blocked government formation and trash collection, as refugees are barred from employment with the impasse. Iraq with its huge internally displaced population has announced a $6 billion bond plan to tackle the problem and gaping budget deficit, and speculative investors may be tempted by 10 percent-plus yields.
Greece across the sea from Turkey was the first Emerging Europe destination to feel the subsequent onslaught, and it has since moved to Hungary, Serbia and elsewhere as a gateway to desired resettlement in Germany and other richer EU members. Hungary’s Prime Minister Orban may be trying to outflank the opposition far-right Jobbik party with xenophobic rhetoric and fence construction, but he has also worked to assuage foreign investors holding one-third of local debt so he can pay for the limited reception under his tough line. Before the crisis the budget was on track to meet Brussels’ 3 percent of GDP deficit threshold, and successful bank Swiss franc mortgage conversion had softened the threat of additional punitive taxes. The stock market through end-August was the top MSCI Index gainer at 25 percent, and deflation was rolled back that could have raised the cost of public debt at 80 percent of GDP.
In Serbia in contrast the stock market has dropped over 20 percent 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 resumed IMF facility. The benchmark 5 percent interest rate is Southeast Europe’s steepest as inflation increases with electricity price hikes. State enterprise divestiture promised for years is proceeding slowly, with many banks and “strategic” firms still off limits. Croatia has also received diverted refugee waves and may turn to the IMF soon with its own high-debt state-dominated economic drag. Leaders in both countries have clearly stated that with cash crunches they cannot handle the flow and 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 reasonable cost, will need an independent tracking mechanism for the proceeds use, 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 currently scrambles to respond it can convene a global working group comprised of government and international organization 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.
Originally Published on bne IntelliNews 22 September 2015
