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Cashing in: Bulgarian cabinet looking at domestic market to refinance foreign debt, but has backup plan in place.

Until recently, the issue of how Bulgaria will refinance its first big repayment of foreign debt was not even on the Government's agenda. The passage of time, however, has limited the number of options to a few unpopular choices--either refinance by issuing new bonds on international markets or count on local private pension funds and banks to come through out of a sense of civic duty. But Finance Minister Simeon Dyankov and his team, however, have decided to use the ace up their sleeve--the 1.8 billion leva in the Silver Fund, the war chest set aside to shore up the state pillar of the pension system.

The Cabinet will try to refinance entirely on the domestic market (although in an interview with Reuters Dyankov left the door open to an Eurobonds issue), but would plug any holes, as necessary, with Silver Fund money. To this end, Parliament is now drafting amendments that would allow the Fund to place up to 60 per cent of its money in Bulgarian government bonds. Whether the Cabinet will use the Silver Fund and to what extent will depend on the interest shown by institutional investors.

The Finance Ministry planned to issue domestic bonds worth a net 500 million leva, but if one adds the refinancing needs to repay bonds due in 2013, the figure swells considerably to 1.6 billion leva. The issuance of such a vast amount of government securities on the internal market and the transfer of part of them to the Silver Fund may prove to be the cheapest and most politically viable option for the Cabinet, but it also has several negative aspects.

To start with, the Government will be both the primary buyer and seller of debt, which is a conflict of interest (normally, the Finance Ministry wants to sell debt at lower yields, while future retirees are interested in getting the highest interest possible). It will also reduce the Governments currency reserves, since the Silver Fund is formally part of the Government's deposit held by the Bulgarian National Bank (BNB).


Finally, any future risks are concentrated concentrated domestically, rather than spread as wide as pos-sible.

When you need cash

Currently, the public pension system state guarantee fund (the formal name of the Silver Fund), has about 1.8 billion leva, less than two per cent of Bulgaria's gross domestic product (GDP). If one is to add the funds from the sale of tobacco company Bulgartabac, due in May, the Silver Fund's account will swell to about two billion leva.


This amount is well short of the figure needed to overcome the chronic annual deficits in the budget of the National Social Security Institute (NSSI), the state body that collects mandatory pension contributions and pays retirement benefits. Furthermore, the funds are manage ultraconservatively and generate interest at a rate lower than inflation. New revenues are modest--by design and by law, new inflows are mainly from privatisation of state companies, a requirement that the government often deftly bypasses in most large transactions, where the seller is not formally state but its State Consolidation Company.

By the time that the Silver Fund is envisioned to be used in several years' time, it is unlikely to have grown by much, unless its investment policy is changed, which is why the active management of its assets, as proposed by the Finance Ministry, is an opportunity to increase the Fund's size, even if it does look like moving state funds from one pocket to another.

The Silver Fund, however, is part of the Cabinet's fiscal reserve and the foreign currency reserve that serve as the collateral backing the currency board and the lev's peg to the euro.

"If the Silver Fund invests in new government bonds issued to repay Eurobonds maturing in 2013, the money will have to be removed from BNB's foreign currency reserves, since these cannot be invested in local government securities," Petar Chobanov, cofounder of think-tank Institute for New Economic Progress, said.

The size of foreign reserves is monitored by credit rating agencies. "When reserves fall sharply, it poses certain a reputational risk for Bulgaria. On the other hand, the collateral of the currency board is in no jeopardy," Chobanov said.

According to economist Georgi Ganev of the Centre for Liberal Strategies, the question is more philosophical in nature--should the money from the Silver Fund, meant to prop up future pensions, be used to buy Bulgarian government debt.

Economist Georgi Angelov from Open Society Institute-Sofia said: "This means that there will be no real Silver Fund because it will have no money, only a Cabinet promise to repay certain amounts in the future. And this is no way different from the NSSI."

According to Angelov, any time there is such a big pile of money, politicians will always be tempted to spend it. Instead, the accumulated funds should be divided into personal retirement accounts, set up for this purpose.

The Cabinet's desire to use Silver Fund money to buy its own securities holds several risks. The first of them is that the money will be locked in the country, which in turn makes them vulnerable to possible domestic shocks.

"Obviously, the Government thinks that its debt is the most secure. In terms of the Fund's management, however, there should be concern because this is putting all your eggs into one basket," Ganev said.

"Apart from that, there is the question of how to determine the yield of newly-issued securities, since the Government may be both the primary buyer and seller of debt," Chobanov said.

Hunger for debt

Dyankov's desire to rely on the domestic market to refinance foreign debt is controversial and has its pluses and minuses. Clearly, it was chosen also for political considerations--dipping into the international markets would come at a heavy public approval cost, since the public opinion remains very negative on the Brady bond swops carried out by former finance minister Milen Velchev (which have cost Bulgarian taxpayers about one billion leva over the past decade because of the US dollar's depreciation).

An international issue would cost more than a domestic one. "There are additional costs, including transaction fees and one-off payments to international credit rating agencies, which will cost between 20 million and 30 million leva. If we raise the funds domestically, all this money will be saved because we would not intermediaries," Dyankov has said.

The question is whether the issuing of so much debt could bleed liquidity from local banks that might otherwise be used for lending. Analysts are divided in their opinions.

"Everything is pointing towards the fact that it is too late to seek funds on the international markets. At the same time, most analysts are skeptical that local investors can buy two billion leva worth of securities, which is the amount needed to refinance the bonds due in 2013," the head of investment at private pension fund DSK Rodina, Ivo Zahariev, said. He said most analysts put the amount of funds available to buy new debt domestically at about one billion leva, and even that would be a serious drain on liquidity.

Ganev disagreed, arguing that the new bonds would sell out because there was sufficient demand for government securities in Bulgaria. "Lending is very cautious at this time, so the higher domestic debt is unlikely to hamper the private sector. Instead it will give investors set on building themselves a safety net the opportunity to do so using attractive debt instruments," he said.

The good news is that after a long period of silence on the subject, with only a year left before the due date of the foreign debt bonds, the Finance Ministry has an idea and a preliminary plan how to proceed. Its next task will be during implementation to rely more on the real market for government bonds and less on the Silver Fund backup plan.

By the time that the Silver Fund is envisioned to be used in several years' time, it is unlikely to have grown by much, unless its investment policy is changed.

Tatyana Vassileva Pouncheva contributed to this report.

Vera Denizova, Capital
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Author:Denizova, Vera
Publication:The Sofia Echo (Sofia, Bulgaria)
Geographic Code:4EXBU
Date:Feb 10, 2012
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