Historic economic literature outlines how when the real (discount) value of a debenture (and or debt) falls below a certain threshold, then why it becomes a sound proposition for a country to buy back its international debt. It is like a company buying back its stock when it has confidence in its management, ability, potential and in its future outlook to determine that its stock at a certain level is under-valued.
Also, side-by-side the idea is to invest in one’s backyard, as no other proposition can be safer than the turf one knows. For countries though, it tends to be slightly different since the governance structure is likely to change with every election and unless there is a consensus on the national economic vision, the economic strategy could also change along with a change in the government. Further, if a national sovereign debt falls below a certain level, it also invariably means that the country is struggling financially and may simply not have the resources or the cash flow to buy back its debt even though it makes good sense to acquire it.
While a lot of financial experts criticise bond buybacks as a ‘”boondoggle” benefiting a country’s creditors—meaning that buybacks are a wasteful use of public money—but when looked at from a broader economic perspective (especially in the case of developing countries) of a socio-political framework that includes potential benefits of buyback for citizens, not just financial market costs, we see that buybacks do not necessarily require a budget surplus via higher local taxes and/or increased austerity measures.
The strategy in such a case is to allow the government to somewhat deviate from the debt brake or balanced budget strangleholds by looking at fresh formations of financial derivatives in public accounts and by undertaking sub-sovereign fiscal decentralisation in developing alternate debt holders, albeit this time in one’s own/domestic private sector’s domain.
For example, post-2008 financial crisis, how the EU bent its fiscal rules to legitimise its bond buyback in the then-prevailing financial and fiscal austerity realities. This led to finding debt solutions through a fine balancing act between financial stability and compliance with the EU’s debt legislature by adopting policies aligned towards using innovative financial accounting engineering solutions in conjunction with the private sector.
So, are buybacks an efficient way to reduce sovereign debt? Answer: Especially post-2008 financial crisis, the possibility of debt buybacks as a way of reducing a country’s debt, particularly in the crisis-ridden Eurozone, has been a reality. Buybacks tend to be a good idea in circumstances in which debt buybacks are efficient, however, the financial managers need to be careful in striking a prudent balance between the nature of the debt where a buyback would be more effective and where instead a debt exchange would be more preferable.
The arguments in favour of debt reduction are well known. A debt overhang reduces the incentives for investment, both foreign and domestic, because of the threat of future taxes. In theory, the efficiency gains resulting from a reduction in debt overhang can be divided between the debtor and the creditors through a bargaining process. An agreement would then involve some “payment” by the debtor (cash or a more secure new debt obligation) in exchange for some debt relief. In practice, however, coordination problems make these arrangements difficult when the creditor body is fragmented.
The benefits from debt reduction accrue to all creditors, whether they participate or not in the scheme. As a result, free riding may hold up the entire process. Interestingly, in the case of Pakistan, where the discount rate of some of our bonds is already touching almost a 92 percent shave-off, this appears to be a very lucrative option.
Against such a backdrop, debt buybacks and/or (voluntary) debt swaps appear to be quite appealing as they may come across as being market-friendly avenues to reduce a country’s debt, especially when this debt is trading at a deep discount and/or the country is paying high costs to attract new external financing. The key of course would be to formulate an innovative strategy and put in place a competent team of financial and business experts who can then productively involve the private sector to help buyback, shift and transfer a sizeable chunk of Pakistan’s debt. Also, at the same time, it would provide clarity on which remaining portion of the debt needs to be restructured through a frank and open dialogue with the lenders.
Finally, the prospects for debt buybacks look better when informational asymmetries drive a wedge between the expectation of future repayment of creditors and debtor. For instance, for a government committed to honouring its country’s obligations and investing in the policies needed to guarantee repayment the “true” value of the debt is close to its face value.
However, the same debt can trade at a discount if the government is not able to credibly convey its commitment and financial markets are sceptical that it will be able or willing to carry out its policy plans. Under these conditions, a buyback would achieve substantial savings.
Further, it could act as a signalling device and improve the country’s access to new external financing. No point in guessing that the latter seems to be the case for Pakistan and the mere seriousness and honest intent on its part to bring its debt to manageable proportions could open up a lot of doors and possibilities.
The key here for Pakistan would be to achieve what one can term as information asymmetries between the government, lenders and the markets, i.e., to convince the lenders, the private sector partners and the market per se of its true ability and intentions, because the success of the exercise would hinge in effectively and credibly revealing to the partners, lenders and the financial markets, that we fall in those good governments and not the ones that cannot be trusted!