By Minga Negash (Ph.D., University of Witwatersrand)
In many respects a Diaspora bond involves an appeal for a sense of patriotism. It means the home country has not been able to finance the foreign exchange component of development projects by borrowing from the open market, or finds it cheaper to finance the project(s) from this source of finance. Diaspora savings can thus be channelled to projects that have multiplier effects in the home country; than being transferred in the form of transfers that have little or no multiplier effects, such as spending in family support and sending gifts in the form of consumables such as clothes and shoes. Decoupling finance from patriotism is not an easy matter for the Diaspora especially at a time when the global financial crisis is taking its toll.
The crisis is now taking its effect on the real economy. There are few economies that are decoupled. The United States’ latest stimulus plan is yet to reverse the frightening level of joblessness and the shrinking demand. Immigrant populations living in the OECD countries are of course sharing the first brunt of the adverse effects of the financial meltdown. Assuming the turnaround is not far, the Diaspora is faced with the choice of investing in the country of residence’s bonds or investing in home country’s debt instruments. One needs to be sympathetic to the plea of the home country; but capital is realistic, and involves greed and security. In this commentary I attempt to show the link between finance and patriotism, and indicate risk mitigation options for making Diaspora bonds more investable. I use the recently issued Ethiopian Electric Power Corporation (EEPCO) Millennium Bond as a case study.
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The central bank, the National Bank of Ethiopia (NBE) has underwritten Ethiopia’s first Diaspora bond. The bond itself was issued by the state owned power utility company (EEPCO), and the debt instrument is being marketed by the state owned bank, the Commercial Bank of Ethiopia (CBE). In practical-institutional terms, the borrower is the Government of Ethiopia. The key features of the bond are as follows. The interest rates are 4%, 4.5% and 5% respectively for 5, 7 and 10 years bonds. The face value of the bond is US dollar 100 and the minimum investment required from a member of the Ethiopian Diaspora is US 500 dollars or its equivalent in selected convertible currencies. The target investors are holders of the Ethiopian passport who are residents outside of Ethiopia, and citizens of foreign countries who can trace their origin back to Ethiopia. The bond’s softeners are (i) the investment can be used as a deposit for borrowings from local banks in local currency, and (ii) the interest is tax exempt at the source. For more details, see Ethiopian government affiliated websites. The bond is expected to be sold through networks in OECD and the Middle East countries. It is not guaranteed by an international investment bank. It is unclear whether the selling networks meet standards for taking deposits and providing investment advice to the investing public. The instrument is not backed by assets. Unfortunately, Ethiopia has no formal rating for its sovereign bond. The best it could have is a “shadow rating” of about CCC-; a rating often associated with a “junk” bond in America, and/or bonds issued by countries that had financial and banking crisis of one sort or another. Ethiopia is not yet a member of World Trade Organization (WTO) and, the risk mitigation methods for an expatriate investor evolve around the country’s accession to MIGA (multilateral investment guarantee agreement) regime some 20 years ago, and agreements through forums such as ACP-EU. It is unclear whether the bond will be covered under MIGA and similar agreements. Furthermore, it is unclear whether Ethiopia has a double taxation treaty with the capital source countries where the target buyer of the bond is resident. Hence, the Ethiopian Diaspora, even though his/her home country is not known for defaulting international debts or delays in contributing membership dues to international organizations, he/he faces a typical investment decision problem.
This commentary is not intended to be a financial advice. It is aimed at sparking a debate about risk mitigation strategies for both the members of Diaspora and the bond issuing and guaranteeing authorities and their advisors. One needs to differentiate between risk avoidance (which in this case is not investing in a Diaspora bond) from actions that can be described as risk hedging strategies. Risk hedging (mitigation) strategies are important in that the investor is also protected from ruining his/her hard earned savings. The risk hedging strategies range from the design of official and homemade risk mitigation programmes. Guaranteeing the bond (at least partially) by international organizations; creating linked products such as retirement, Medicare, travel, leisure, home ownership, education plans are examples of schemes that add additional features to the bond, and make the product “exotic”. Failing these, the rate of return must be high enough to compensate for the level of risk that is faced by the investor in Diaspora bonds.
The weakness of institutions suggests the weakness of the institutions of the State. Many Sub Sahara Africa (SSA) countries have had various forms of stigma that include ‘failed’, ‘diseased’, ‘fragile’ and ‘dysfunctional’ states. If this is the case, one might conclude that lending to a failed state is the worst thing one can do. Hence, a member of a Diaspora from failed state must rather take out, as it seems to be the case, his/her siblings out of that state. He/she would send remittance if the siblings are caught in conflict zones or are literally held hostages. Some studies indeed show that this is the case. The remittance statistics for Burundi, Eritrea, Liberia and Somalia were relatively high when compared to other SSA countries that were relatively stable. Notwithstanding this, an investor in a Diaspora bond has to ensure that his/her retirement and savings are kept in the safe regions of the world. Hence, uncertainty, weak and non-existent institutions, bad laws, problematic law enforcement and administrative processes, and poorly designed financial products make resource channelling to SSA countries difficult.
In his famous book, the Brief History of Science, Stephen Hawking attributed the discovery of the uncertainty principle to Werner Heisenberg. Heisenberg suggests that uncertainty is a problem of not knowing the velocity of a particle. In finance, the problem of uncertainty is twofold: - First, it is a problem of not knowing the value of an asset (the particle), and second, as in science it is a problem of not knowing the velocity (movement) of the financial product especially in times of crisis. Big banks, investment houses and insurance companies whose assets by far surpass the aggregate GDPs of the entire SSA countries have collapsed. This failure is despite complex regulation, listings in organized markets, rating by credit rating agencies, complex contracts and judiciary, “high quality” accounting and audit standards and the applications of latest managerial, compensation and prediction (including bankruptcy) tools. Hence, the purpose of history, as in credit history and the failure of the banks, is to learn from the past as long as there is strong association between the past, the present and the future. The uncertainty problem associated with Diaspora bonds is indeed complex.
Ratha, Mohapatra and Plaza (2008) in their study of capital inflows from Diasporas, observed that international financial flows to developing economies occur in number of directions. They are through official development assistance (ODA); foreign direct investment (FDI); portfolio of debt and equity; bank lending, and personal and institutional remittances. In terms of the order of importance, they rank the sources of international flows to SSA in the following order: - ODA, private sector short and long term flow, FDI and remittances. Nielsen and Riddle (2007) also examined why Diasporas invest in their homelands. They observed that emotions, sense of duty, social networks, strength of Diaspora organizations and returns are important factors. Leblang (2008) shows that migrant networks are useful conduits of capital flows, and the major assumption is that migrant networks decrease the level of information asymmetry between a borrower and a lender. Anecdotal and statistical evidence show that Ireland, Israel and India have benefited from this source of finance. The World Bank experts also note that India, Lebanon and Sri Lanka have been successful in issuing Diaspora bonds. They note that India has been able to raise considerable funds by offering rates that ranged between 7.2% and 8.9%, and getting its bond rated as BB. The present problem is whether this success can be replicated in SSA countries.
The behavior of the Ethiopian Diaspora, which according to the Ministry of Foreign Affairs of Ethiopia is estimated at about 2 million if united, has the potential to address not only what economists refer to as the Lucas paradox, a phenomena that is often associated with the non migration of capital to developing nations despite high return opportunities, but also mitigate risk and influence home country policy. Hence, the challenge is for the Diaspora as it is for the issuing and underwriting authorities. According to the March 2008 World Bank estimate, in 2006 the Ethiopian Diaspora contributed 173 million US dollars (1.3% of GDP) while emigrants from neighboring Kenya and the Sudan respectively contributed to the tune of 5.3% and 3.1% of the GDPs.
The World Bank’s statistics however is contradicted by the data that is coming from Ethiopian government sources. The European Union for example relies on data supplied by the NBE, and estimates the financial flow from remittance at about 3.6% of GDP in 2005. Similarly, migration statistics is also unreliable, and the statistics for the Ethiopian Diaspora can be a wild guess. Excluding conflict and drought driven displacement, migration to OECD countries, the Middle East and Southern Africa has been increasing in recent years. In this respect, though a dated statistics, the United States migration office estimated the legally resident population of Ethiopian origin at about 450 thousand; with the emigrants having a median age of far less than 35 years; about 30% of them having at least a Bachelor of Science (BSc) or equivalent degree; and 84% having a school leaving certificate. This statistics significantly understates the true migration picture of Ethiopians to the United States, but provides some pointers.
The comparative statistics for other countries does not indicate that the Ethiopian immigration figure is out of line. In fact an OECD study that was published in 2000 does indicate that SSA countries do not dominate world migration statistics. From SSA region only Nigeria featured as the 27th country out of 28 countries that were covered by the study. Notwithstanding this, for the purposes of this commentary one can conclude that the Ethiopian Diaspora, if benchmarked by the statistics obtained in the United States, however dated and understated it may be, is a skilled and semi skilled population group. In other words, it can be a conduit for the flow of capital, knowledge and skills.
According IOM (International Office for Migration), the Ethiopian government has a "very active" approach to Diaspora affairs. It states that in 2002, the Ethiopian Ministry of Foreign Affairs inaugurated a General Directorate in Charge of Expatriate Affairs to (1) serve as a liaison between the government and the Diaspora; (2) encourage the active involvement of the Diaspora in socioeconomic activities in Ethiopia; (3) safeguard the rights and privileges of Ethiopians abroad; and (4) mobilize the Diaspora to improve the public image of Ethiopia. Evidence shows that the success of this office is mixed. Critics argue that its work has been largely divisive. The Directorate’s image was further damaged by a leaked document about the task that was given to it in combating the international campaign for the release of the jailed CUD leaders.
The Diaspora was labeled as “extremist” and its prominent members and distinguished academics were put on a “wanted list”. The churches and the mosques are divided along political and ethnic lines. The re-imprisonment of Judge (Miss) Birtukan Mideksa (the leader of the repackaged CUD) and government’s futile media campaign through its “experts” (see for example www.aigaforum.com; www.walta.com) has started to backfire. The horses for the next election (if there is a free and fair one) are being made clear. In short, the Ethiopian Diaspora has a major problem of knowing the correct path of change, and has not been able to effectively influence the government’s political, economic, foreign and social policy.
Accuracy and reliability are two key features of information that are needed for making economic decisions. Most of the information that is reaching the Diaspora contains elements of propaganda. It suffers from representational faithfulness. In finance and accounting representational faithfulness and relevance are key factors for determining fundamental value of a security such as a bond. Property right, investor protection; the rule of law, the credibility of financial statements of the borrower and the underwriter, cash flows and earnings are critical factors in lending decisions. Policy predictability and the integrity of government officials are also important. In short negative news dominates positive news. The death of the CEO of CBE in mysterious circumstances and the extended imprisonment of the bank’s senior executives, the discovery of fake gold in the NBE, the CBE’s recent inability to collect the loan it advanced to MIDROCK’s owner, all adds to the problem of trust.
Another interesting question that the issuer of a bond must answer is why should a resident of for example the United States buy the millennium bond when in fact there are competitive municipal bonds that are also tax exempt in the United States? Why is it that EEPCO’s bond has a 4% interest when Indian bonds are offering 7% or 8%? Can an Ethiopian Diaspora member make use of arbitrage opportunities to benefit from Indian bonds? What is the implication of the transaction for taxation at the source of the capital? Will the bond be sold only at face value or will it have some kind of market value?
The February 1, 2009 edition of the New York Times illustrates the problem of bond valuation at a time of crisis. Writing on troubled banks, the newspaper illustrated the problem that is faced by one financial institution that owns a “toxic” bond. The owner of the bond calculates the value of the debt instrument at 97 cents on the dollar, or a mere 3 percent loss. According to Standard and Poor (S& P), one the major rating agencies, the estimate is that the bond is worth 87 cents, based on the current loan-default rate. The rating agency also stated that the bond could be worth 53 cents under a “bleaker situation”. The bond under discussion also recently traded at 38 cents on the dollar. If there was an active market for Diaspora bonds, what would be the value of EEPCO’s Millennium Bond? Will it do better or worse? In conclusion, the buyers of Diaspora bonds, Ethiopians and non Ethiopians alike, face the problem of the art dealer depicted in Abraham Brilof’s (1981:1) famous book entitled, “More Debits than Credits”.
“An art dealer bought a canvas signed “Picasso” and travelled all the way to Cannes to discover whether it was genuine. Picasso was working in his studio. He cast a single look at the canvas and said, “It’s fake.” A few months later the dealer bought another canvas signed “Picasso”. Again he travelled to Cannes and again Picasso, after another single glance, grunted, “It is fake”. “But cher maitre “expostulated the dealer, “it so happens that I saw you with my own eyes working on this very picture several years ago.” Picasso shrugged [and said]: “I often paint fakes.”
The writer can be reached at Minga.Negash@wits.ac.za.
