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Eurobond, amid the most severe global economic crisis, aimed at debt rescheduling and budget support

This week, Republic of North Macedonia issued the eighth Eurobond on the international capital market. This auction was a real success for our country, since it demonstrated the great confidence of international investors in our economy, as well as its outlook. Huge investors’ interest in the Eurobond (by 2.3 times higher than the offer), as well as the reached 1.625% interest rate at historic low, speak in favor of highly valued policies being pursued, as well as a low-risk economy as considered by the investors. When making a comparison, average as regards the interests on all previously issued Eurobonds accounts for 5.05%, being by 3.1 times higher than the interest on the newly issued Eurobond. We have become a NATO member before launching the EU accession talks, with a stable political climate and relaxed inter-ethnic relations in place, coupled by credible economic policies with a clearly set medium-term fiscal consolidation and growth prospects, all this having positive effects on investors’ confidence, even amid pandemic. Successful issuance of the eighth Eurobond was also a result of the exhaustive efforts put by the professional staff in the Ministry of Finance, being directly involved in the preparation process related to the Eurobond issue and the consortium of world-renowned banks, which supported this process, as well as all line ministries and institutions making their contribution to the preparation of the Prospectus on Macedonian economy profile.

Eighth Eurobond is peculiar given that it is has been issued in times of the most severe global economic crisis caused by COVID-19, thereby attaining the lowest interest compared to all previously issued Eurobonds, being also lower compared to the countries in the region and some EU Member States with even higher credit rating assigned in this period (observed as annual expenditures related to interest payment, regardless of the difference in the maturity of the Eurobonds).

At the press-conference wherein I gave an account of the eighth Eurobond-related auction, one of the journalists posed an intriguing question – would I have been in favor of the Eurobond issuance if I had not been the Minister of Finance. Inspired by this question, the elaboration of which would have taken much more time than the few minutes I had, I decided to put my thoughts on paper, pertaining to government securities, public debt and its role in the economic growth, as well as the risks it brings.

 

Experience as regards the issued government securities

Until 2004, our country issued neither domestic nor foreign government securities. As part of the previous Strategy for Development of Government Securities Market, in January 2004, Ministry of Finance carried out the first issue of government securities by issuing 3-month treasury bills on the domestic market. Due to the greater interest shown by investors – being expected given that it was a matter of risk-free financial instrument, 6-month treasury bills were soon issued, followed by the 12-month treasury bills and a 2-year treasury bond promoted the year after. Thus, a primary domestic government securities market was established, being of great significance for the ongoing servicing of the liquidity budgetary needs, being at the same time another quick, transparent, high-quality source for access to capital for financing the budgetary needs.

In December 2005, Republic of North Macedonia had its first promotion on the international capital market by issuing the first Eurobond. The interest rate on the 10-year Eurobond amounting to EUR 150 million, accounted for 4.625%, whereby these funds were used for rescheduling the debt towards the London Club of Creditors. What is even more important is the fact that by issuing this Eurobond, the country has been, for the first time, put on the map of institutional investors from all over the world. This provided for creating another opportunity and a new instrument for quicker access to capital, in case a need arises therefor.

Over the past 16 years, the domestic capital market has developed, other short-term and long-term instruments have also been offered, ranging from one-month treasury bills to 30-year treasury bonds. Upon the first Eurobond, another seven Eurobonds 2009, 2014, 2015, 2016, were issued on the international capital market in 2018, 2020 and 2021, with different amount, maturity and interest rates ranging from the lowest one, accounting for 1.625% in 2021 to 9.875% interest rate on the Eurobond issued in 2009, with most of them bearing an interest rate, which exceeded 4.5%. Not all of these securities were equally economically justified, and a number of political decisions related to these instruments came under sharp criticism from the public.

 

Growth higher than the interest (g>k)

Given the lesson learned from the experience in the past period in terms of government securities, one can conclude that these instruments is what the financial system of a modern economy undoubtedly needs, but when managed improperly, they may bring about many risks, among which public debt accumulation. When issuing each of them, it should be taken into account that the cost should be lower than the benefit generated therefrom, i.e. the future growth rates of the Gross Domestic Product should be sufficient for financing the debt.

More specifically, the 2021 Eurobond we have now issued, is economically justified. It will be used for refinancing the Eurobond issued in 2014, amounting to EUR 500 million, the interest rate of which accounted for 3.975%. The current interest rate accounts for 1.625%, which will generate interest savings worth EUR 82.25 million in seven years. Furthermore, real GDP growth is projected at 4.1% (or 5.6% growth in nominal terms), i.e. it is by 3.5 times higher in relation to the interest rate on the Eurobond. This means that the remaining funds from the Eurobond, amounting to EUR 200 million, to be used as budget support, will produce multiplied economic value in relation to the cost to be paid therefor. Anyway, when making comparison with the projected real GDP growth rate, if one takes into account the inflation in the EU, as well as in our country, accounting for 1.5% in line with the 2021 projected rate, it can be easily calculated that the real interest rate on the eighth Eurobond accounts for 0.125%, i.e. the nominal rate is 1.625% reduced by the projected 1.5% inflation.

 

Public debt and GDP growth dynamics

If we take into account the last two decades, U-shaped curve has been observed as regards public and government debt. In 2002, public debt accounted for 43.2% of GDP, while government debt accounted for 40.5%. In the course of the following two years, both public and government debt were reduced, being below 40%, whereby in the 2005-2008 period, public and government debt recorded a sharp decline, accounting for 23% and 20.5%, respectively in 2008, being the lowest level of debt for a period of two decades. Reduction of public and government debt in this period was mostly a result of the several activities related to early repayment of the debt towards the international financial institutions (the London Club, the Paris Club of Creditors, the International Monetary Fund, the World Bank, the European Investment Bank and the domestic Bond for Rehabilitation of Stopanska Banka), financed via public property privatization.

In the 2008 – 2016 period, public and government debt increased continuously both in absolute terms and as a percentage of GDP. The 23% public debt picked up to 48.8% by 2016, while government debt increased from 20.5% to 40.4%. During the respective period, average economic growth rate accounted for 2.5%.

In 2017, 2018 and 2019, the debt was stabilized, however, as of the onset of COVID-19 crisis and the need to finance the expanded budget deficit, arising from the reduced revenues, as well as the increased expenditures due to the rising financing needs resulting from the COVID-19 crisis, public and general government debt picked up to 60.2% and 51.2%, respectively.

As of the onset of the COVID-19 crisis, the increase in the budget deficit and the government debt over the past year featured almost all economies throughout the world. In Europe, only Norway recorded a decline in the government debt by 1.3 percentage points in 2020 compared to the previous year. In line with the IMF data, highest increase in the government debt in Europe in 2020 compared to 2019, was observed in Spain, 27.5 percentage points surge or with an actual government debt accounting for 123% of GDP, followed by Italy, recording a government debt increase by 27 percentage points or a government debt accounting for 161.8% of GDP, as well as Greece with the government debt increasing by 24.2 percentage points, the government debt of which accounted for 205.2% of GDP. As for the region, in addition to Greece, Albania recorded highest government debt increase by 15.6 percentage points, which government debt accounted for 83.3% of GDP, followed by Slovenia, which government debt increased by 14.9 percentage points, with government debt accounting for 81% of GDP and Croatia recording increase in the government debt by 14.5 percentage points with a government debt accounting for 87.7% of GDP. Out of 38 countries, Republic of North Macedonia recorded lower government debt than 24 countries, as well as lower increase in the government debt in 2020 than 22 countries. What is particularly important is for the debt to be sustainable, which according to IMF estimations in its Report on Macedonian economy, as of April 2020, should not exceed 70% of GDP. Economic growth may be attained through public debt (debt-fueled growth), however the public debt cannot be the main driving force of growth.

 

Fiscal consolidation and accelerated growth aimed at debt stabilization

On the medium run, i.e. by 2025, according to the projections in the Public Debt Management Strategy, public debt will stabilize and will be reduced to 58.8%, i.e. below the level set under the Maastricht Criteria, while government debt will be reduced to 51%. This will be accomplished via the plan and measures aimed at gradual fiscal consolidation, i.e. gradual reduction of budget deficit on one hand, as well as by intensifying the economic growth, i.e. generating higher value added, which will provide for easier servicing of the debt falling due, on the other. The medium-term framework, as per which we take actions, and upon which this year’s Budget has been based, includes measures and policies focused on both aforementioned objectives.

With respect to fiscal consolidation, deficit is projected at 4.9% in 2021, being lower by 3.6 percentage points compared to last year’s projected budget deficit. Our plan and expectations are for budget deficit to gradually narrow each year, thus reaching -3.8% in 2022, -3.2% in 2023, -2.9% in 2024, and -2% in 2025, which will be below the Maastricht Criteria of -3% of GDP.

Fiscal consolidation is planned to be accomplished by: i. Improving the budget revenue collection (by enhancing the capacities and improving the services of PRO and the Customs Administration, via measures aimed at reducing the grey economy, preventing and combatting corruption, etc.), II. Reducing and restructuring budget revenues (by cutting the non-priority and non-essential costs, reducing the current expenditures, greater support to the private sector, innovations and boosted competitiveness, high allocations for social protection and revision of methodologies for transfers and subsidies, etc.) and III. Changes in the sources of financing the budget deficit (such as public debt rescheduling and issuance of development government bond, greater diversification of the sources of financing the deficit, as well as financing and realization of certain projects through public-private partnerships, concessions and establishment of a Strategic Investment Development Fund, with a possibility to mobilize the financial capital from international financial institutions and the private sector).

What is also planned is reducing the current expenditures by streamlining the public administration expenditures, optimizing and increasing the efficiency of the public administration, optimizing and reorganizing the public sector, and digitalizing considerable portion of public services. For the purpose of streamlining the expenditures, the emphasis is also placed on improving the execution of capital expenditures through the established CAPEF (capital expenditure efficiency) mechanism aimed at “punishing and rewarding” budget users by reallocating budget funds throughout the budget year from those with poor execution of capital expenditures to those with better execution thereof, coupled by Public Investment Management Assessment – PIMA and methodology for assessing the realization of capital investments via Smart Key Performance Indicators, as well as establishing bodies in charge of monitoring the realization of capital investments.

Intensification of economic growth in the medium term will also provide for stabilizing the debt due to the expanded fiscal space required for its servicing. Redesigned fiscal policy and the Strategy for Economic Recovery and Accelerated Growth (SmartER Growth) will provide for intensifying the economic growth in the period to come, getting the economy back to the pre-crisis growth trajectory in the second half of 2022, as well as ensuring accelerated growth dynamics thereafter. In line with the indicative forecasts, economic growth in 2025 is expected to reach 5.9%, while in the 2026 – 2030 period, average economic growth rate is expected to stabilize to 5.75% annually. This is planned to be attained by creating more competitive business climate, being export-oriented with firm support for entrepreneurship and innovations, via better access to finance and technology adaptation, modernization of the sectors with comparative advantage, tax reform, as well as by combatting the grey economy, digitalizing the economy, developing human resources by making investments in the field of education and science and the health sector, through measures aimed at intensifying the activity of the working able population, orientation towards “green economy”, etc.

I would like to hereby point out that the debt amount is another macroeconomic indicator, which however does not illustrate the strength of the economy and the living conditions of the citizens. Government debt accounts for 73.3% in Germany, 108% in Great Britain, 118.7% in France, 123% in Spain, 161.8% in Italy…. government debt of the Republic of North Macedonia accounts for 51.2%, which however is not a sign of a stronger economy or better economic performance than theirs. What is crucial for the next period is to focus all our efforts and strategic actions on accelerating the growth of our economy in order to double the growth rates as opposed to the previous average, which ranged around 2.5%, thereby pursuing a prudent public debt management policy, which will provide for public debt sustainability. Debt is justified only when the economic growth is boosted therefrom.

 

“Golden Rule” of economic growth and public finance

The economic theory of growth and prosperity, which usually observes growth factors in the long run, has given rise to extensive scientific debate over the optimal and sustainable ratios as regards the growth factors, starting from Cobb-Douglas and the exogenous neoclassical growth models broadened by the technological progress in the Solow Growth Model, followed by Robert Barro’s recent endogenous-growth models – putting emphasis on economic policies aimed at bolstering human capital, innovations and knowledge, as well as Lucas ‘rational expectations with additional structural and dynamic micro-founded macroeconomic models, i.e. the motivation of economic agents to change their behavior on the market of goods and services (households on the demand side, i.e. consumption and producers on the supply side, i.e. investments), as well on the labor market (employees and employers) and the capital market (entrepreneurs and investors) respectively. We can also hereby add on the opened debate in the field of economics, pertaining to the rules versus discretionary fiscal and monetary policy, however, given the limited time and space, this debate will be broadened on another occasion.

“Golden rule of economic growth” according to the growth theories is considered to be the level at which the ratio of consumption and savings, i.e. investments, provides the same amount of capital per effective worker, taking into account the depreciation, the population growth and the technological development, and thus ensuring constant returns to scale (read economic growth). However, endogenous growth models in this equation also include the role of economic policies in generating growth by boosting growth generators, as I mentioned above – support for human capital, innovations and knowledge in order to increase the productivity of the economy. This also adds to the issue of financing growth, i.e. public finances, budget deficit and public debt. With respect to these issues as well, the economics debate has been opened, also carrying on as regards the so-called “golden rules of public finance”, i.e. borrowing only for public investments (productive goals). If we enrich this discussion with the real business-cycle and economic crisis theories, the debate will surely become much more complex. However, it can be said that there is a consensus as regards public finance in the evidence of fiscal consolidation being an important factor in ensuring sustainable growth in the medium term. Simply said if we want to financially support growth, in case there are no sufficient own savings in place, we can attain such growth by borrowing, however, it should be economically justified so as to provide for sustainable growth. From intertemporal and intergenerational aspect, if we borrow today, it means that the borrowed funds should be repaid tomorrow, which on the other hand means that if we make an investment today, we should reap the benefits therefrom tomorrow, or if a generation borrows and the next one should repay this debt, it is understandable that the later should reap the fruit of such decision.

As regards the public debt, the level of debt, the debt cost and its purpose will remain to be issues for discussion in the economic theory and policy, whereby as for each country separately, depending on the economic context and condition, this topic justifiably causes profound public debate with pro and con arguments in view of the future economic growth and prosperity of this and the future generations.

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