Forex Needs and the USD

Forex Needs, USD $30 million Note and the Race against time

The recently launched USD $30 million  Fixed Rate Notes (“The Notes”) has—like most major macroeconomic decisions—generated its fair share of public commentary, and rightfully so. After all, the issuance of the Notes comes on the heels of recent downgrades by rating agencies such as Moody’s that has shown Belize government’s securities to be falling deeper into “Not Prime” territories, a classification that signals high-risk to investors.

With those ratings, it is also no surprise that The Notes carry a relatively high 6.5% coupon rate, as the government is clearly trying to pique the interest of yield-hungry investors who may be willing to take on the higher risk as the so-called ‘safe haven assets’ like the 5-year US Treasuries witness depressing yields of about 0.34%. It was only a few months ago when US 5-year Treasuries yielded closer to 1.4%, but uncertain global economic conditions have inspired investors to increase their demands for haven assets, thereby, pushing up those assets’ prices. It must be recalled that bond prices move inversely to their respective yields.

This holds true even for Belize’s US Dollar Bond due 2034 (more commonly dubbed locally as the “Superbond”). The coupon on the Superbond is 4.9375%, but with the prices being pushed down to about 38 cents on the dollar, Business Insider, an online publication, has the Superbond’s yield pegged closer to 14.2%. This, of course, is the case when several developed countries’ 5 to 10-year instruments are producing “negative” yields (see Germany, Belgium, and Japan, for example). In those cases, the investor may actually be losing money upon the maturity of those haven assets, but it might have been deemed a milder loss relative to some worse-case alternative.

So, let’s return to the “The Note”. If discussed at par, it would be yielding 6.5%. Are there comparable yields out there for instruments with similar maturities? Of course, there are. This includes countries such as Russia (5.01%), Brazil (5.45%), South Africa (7.71), and India (5.43%), most of which carry “Not Prime” ratings from Moody’s. Consequently, any investor that buys any of these 5-year instruments should be very much aware of the associated risks they are taking in exchange for the higher yields.

The WHY

This then brings us to “The Why” component of The Note. What is this 5-year Belize note intended to address? It is no secret that the most pressing problem is that the country’s single largest source of foreign currency (FOREX) inflows has been disabled due to the “lockdown” measures associated with the COVID 19 pandemic.

As far as Belize’s Current Account Balance for 2019 is concerned, the Tourism sector alone accounts for more than 42% of FOREX earnings (with the Government’s June 17^th release placing it as high as 60%).  These factors, among others, have helped to inform the Central Bank of Belize (CBB)’s projections of a BZD $1.3 billion short fall in FOREX inflows, a figure that represents close to half of the 2019 total earnings. According to the International Monetary Fund (IMF), Belize’s Current Account Deficit (CAD) will more than double from a deficit of 7.8% of GDP in 2019 to 18.6% in 2020. To help put that into perspective, CBB data indicates that the CAD for 2019 was $354 million.

For an economy that has only recently started to maintain an import coverage ratio at the 3-month (recommended) benchmark, and for which the external asset ratio must be kept at or above 40% of liabilities (see section 25 (2) of the Central Bank of Belize Act) as part of the apparatus designed to preserve Belize’s peg to the US Dollar, this sort of drying up of FOREX presents a plethora of challenges.

As far as import cover is concerned, simply put, the standard 3-month is a recommended level that is deemed to be ideal to help provide countries with sufficient buffers to withstand external crises. Exactly! That includes external crises like the current “Lockdown” recession brought about by the COVID 19 pandemic. Belize entered the current crisis with just above 3-months’ cover, but the forced hibernation of the tourism sector is starting to push the limits of those slim buffers. Add to the equation reduced earnings from commodities exports due to a combination of suppressed prices and supply-side challenges brought about natural disasters (including the recent drought) or crop diseases then it becomes especially clear that the Belizean economy is in a potentially precarious position.

In terms of the External Asset Ratio, slips below this legal threshold have been more scattered throughout Belize’s post-independence history, especially when looked at on a monthly or quarterly basis. However, in 1984 to 1985 and for more than half the months in 2006, Belize had fallen below this limit before recovering. In 2006, the CBB’s annual report for that year explained that the downward trend was due to external bondholders exercising “an early put option on notes issued by the Government in the previous year”. In short, a “put option” on a bond allows the bondholders to force the issuer (in this case GOB) to repay the principal on the instrument prior to its maturity date, and may be used when investors’ outlook on the security’s prospects is grim.

As of March this year, before the April 1^st State of Emergency (SOE), the CBB’s data placed this ratio at 52.7%, down from last March’s 59.2%. Actually, the first quarter averages for the last five years (beginning in 2016) have been 80%, 69%, 65%, 59%, and 54%, respectively. That’s correct. There’s been a downward trend even before COVID 19’s “lockdown”; therefore, it is not difficult to imagine that the situation has deteriorated even further, and the upcoming Superbond interest payment is not helping matters. As a result, GOB’s June 17^th announcement that it will seek the consent of bondholders for interest capitalization (or any other form of renegotiation) was to be expected.

Fundamentally, GOB has two options: either shore up FOREX or curtail its outflows. The Note’s issuance obviously falls under the former, while the interest capitalization falls under the latter. Also falling under the curtailing option are the incipient signs of FOREX rationing with commercial banks reducing limits on corporate credit cards and calling on clients to utilize wire transfers. The use of the electronic transfers would allow the banks and the Central Bank to track the uses of the available FOREX given that the entities would have to obtain the requisite permit.

What about the Rapid Financing Instrument by the IMF?

Okay! So, basically the country needs foreign exchange, and unfortunately the body blow to the tourism sector working in tandem with other variables has depressed inflows: That’s the “why”. There have been questions raised as to why the government did not pursue the low-interest financing under the IMF’s Rapid Financing Instrument (RFI). After all, Jamaica, using that facility, was able to obtain US$520 million for Balance of Payments (BoP) support.

That is a valid question. However, aside from the long queue explained by the Financial Secretary in a June 17^th media interview, it is important that nobody adopts the assumption that Belize could have borrowed anything near to what Jamaica received. Jamaica’s quota with the IMF amounts to, in Special Drawing Rights (SDR) terms, 382.9 million, which converts to about US$520 million. Belize’s SDR quota with the IMF is 26.7 million, which converts to about US$37 million—just about 7% of what Jamaica was able to borrow under the RFI.

Considering the shortfall briefly outlined above, the apt question if the government was ONLY considering the RFI US$37 million would have been whether that alone would be sufficient to tide Belize over until the economy (including tourism) reopens. Frankly, this is the epitome of a rock and a hard place, and it behooves GOB to employ any and all legal means to ensure that sufficient reserves are maintained.

Is it Legal?

Note, however, we said “legal means”. The Opposition has sounded the alarm as to the possibility that The Note may not be covered by Belize’s laws. This entry will not dabble too far into the legal side of the argument, especially as the interactions between the Interpretation Act and the Treasury Bills Act leads to the legitimate conclusion that this uncharted territory may not have sound legal footing. If that is indeed the case, the government ought to correct this lacuna in the law as soon as possible.

To Conclude

There is only so much that could really be elaborated upon in a newspaper column; however, the points being made here are straightforward: First, internationally speaking, there are yield hunters that would willingly take the calculated risk of obtaining higher yields relative to low-yielding haven assets. Secondly, with the knowledge that yield starved investors may be interested in a (relatively) high-yield 5-year treasury, the government has a responsibility to shore up its foreign reserves so as to maintain Belize’s monetary stability, especially considering the massive hole left by the forced hibernation of the tourism sector. It would have been irresponsible if the Government was not trying to take proactive measures during these uncharted times. Speaking of “uncharted”, yes, if the consensus among legal minds is that The Note is not appropriately covered by our laws that must be fixed posthaste; however, that does not detract from the macroeconomic reality that engendered the need for the initiative.