"As long as I am paid, I don't care where the money comes from. But I will have to think 10 times before I lend to another Turkish municipality again."
This was the reaction of a European banker to a new phenomenon in the Turkish borrowing scene: municipalities which are refusing to pay their debts to foreign banks.
The trend was started by mayors of the Islamist Welfare Party Refah, which won the greatest number of votes in the December general election, and has just formed a coalition to replace the caretaker government of Motherland party leader Mesut Yilmaz. Refah also controls a large number of municipalities, including Istanbul, Turkey's most populous city, and Ankara, the capital. It was the mayors of these two cities who first told the treasury that they would not be paying their foreign debts.
Melih Gokcek, the Ankara mayor, first came to the nation's attention with his comments on an abstract statue erected in the capital by one of his predecessors. "If this is art, I spit on it," he said. He seems to have the same disdain for his predecessor's foreign debts. Ankara is among the biggest non-payers and has already declined to pay a Dm150 million bond arranged by Dresdner Bank, according to banking sources. (Dresdner Bank declined to comment.)
But so far crisis has been averted because the central government has been prepared to take over repayments. Ankara municipal bonds valued at ¥8.5 billion, sold on the Japanese shibosai market in private placements, matured in June and were picked up by the treasury. A spokesman for Nomura, the securities company involved in the placement, confirmed that the debt had been paid on time. He would not be drawn on how possible non-payment might affect Nomura's future involvement in Turkey, but was not overly concerned about its other two placements with the municipality. These total ¥54.6 billion yen, and mature in March and November 1997.
Turkish newspapers quote Gokcek as saying that the debts were made not by him but by his predecessor (a social democrat) and should be paid by him. But Sureyya Oral, his spokesman, says: "They don't pay us - we don't pay them." He meant by this that funds due to Ankara municipality were being blocked by the government to undermine the Refah municipality so that it would be perceived by the public as an unsuccessful administration and lose votes.
Municipalities derive a substantial portion of their revenue from allocations made by the central government which channels a fixed percentage of tax revenue in their direction. It is true that the treasury is siphoning away funds allocated to non-performing municipalities at the state-owned Iller (provinces) Bank. According to a source close to the treasury, the treasury started doing this after the municipalities disowned their debts, not before. And, in any case, the sums the treasury is obliged to pay are vastly greater than the sums it is obtaining from Iller.
The foreign loans secured by municipalities are exclusively for infrastructure projects. Some municipal debts are guaranteed by the treasury and others are not, but the treasury is servicing municipal debts regardless of their status. The government is forced to pay because default by a municipality, even in connection with a debt unguaranteed by the state, could lead to country default owing to cross-default clauses. Without exception, municipal loan agreements contain clauses which, in the case of one default, trigger off the default of all other loans. No-one from the treasury was prepared to comment. But foreign bankers say that officials are deeply embarrassed and view the development as something that could undermine the creditworthiness of Turkish state institutions as a whole.
"As long as the treasury pays, the market will remain open. If they default, the market will close completely on Turkey," says an American banker.
But John Stanley, associate director of capital markets at Nikko Bank Europe, believes that the reaction of investors would vary if the municipality defaults. "Japanese investors would probably tar Turkey with the same brush if the municipalities defaulted, and not get involved at all, whereas European investors might be more pragmatic and distinguish between the municipalities and central government." As for the future, he says that if the treasury made it clear that it would not cover municipal defaults, there would be virtually no interest in investing or arranging issues.
The source close to the treasury says that the foreign currency debts of municipalities were between $8 billion and $10 billion. The treasury has already repaid debts of between TL30 trillion ($370 million) and TL40 trillion owed by the municipalities of Ankara and Istanbul and is expected to pay back still more by the end of the year. Rusdu Saracoglu, a former cabinet minister and central bank governor, recently told an international conference that extra-budgetary spending this year - partly caused by the municipalities' refusal to pay - would amount to an estimated TL800 trillion (out of a total budget deficit of TL1,800 trillion).
Is the behaviour of Refah municipalities a measure of what Refah will do now it has formed a government? Could Refah consolidate the national debt?
Many bankers and officials believe that although Refah has little sympathy for the west, it would not be mad enough to set in motion a chain of events which could lead to Turkey's ostracism by the international markets.
"I don't want to think that Refah is reckless or brainless enough to do such a thing," says a senior Turkish official.
The irony is that while groaning about the municipalities, the treasury has recently given the go-ahead to the municipality of Izmit to raise Dm200 million through an international syndication. The treasury gave "fully unconditional and irrevocable guarantee" for the two-year facility, which will be arranged by Dai-Ichi Kangyo, Fuji and Sumitomo. The Izmit mayor belongs to the social democratic Republican People's Party.
Metin Munir
MICROFINANCE
Small lenders count too Lending to the working poor of the developing world is a business that few mainstream investment banks have ever considered. But they will not overlook it in future. Attitudes are changing as bankers see how local institutions which specialize in small-scale lending - known as microfinance - can turn a mass of tiny loans into a profitable business.
Banco Solidario in Bolivia, Grameen Bank in Bangladesh and Indonesia's Bank Dagang Bali are not known names in the financial markets. But they are all thriving as established microfinanciers. As these institutions prosper, they are keen to raise capital on the international money markets.
The concept of microfinance is simple: sums between $2 and $600 are lent to small, labour-intensive, low-technology enterprises at market rates. Once the recipients have proved that they can pay back the money, they are eligible for borrowing larger sums. In most cases customers must open a savings account as part of the deal.
In many countries, the working poor previously had to rely on moneylenders for capital. Their interest rates were so extortionate that borrowers could not prosper, and most got further into debt. By receiving more manageable loans from microfinanciers, argues Marguerite Robinson, an institute fellow at the Harvard Institute for International Development, borrowers are now able to expand their businesses and generate profits:
"In Indonesia moneylenders charge a flat rate of interest of between 7% and 40% a month," explains Robinson. "Bank Rakyat Indonesia, however, charges just 1.5%. It is therefore the formal financial sector and not the moneylenders which has the ability to make microfinance effective and profitable for all."
One bank which may soon enter the Eurobond market is Banco Solidario in Bolivia. The bank was established in 1992 with the bulk of the lending portfolio from Prodem, a non-governmental microfinance institution set up six years earlier by the US-based non-profit organization Accion International. By 1995 the bank's loans totalled over $83 million, and its 63,000 customers represented 37% of Bolivia's banking clientele. Banco Solidaro's non-repayment rate is an astounding 0.2%, and it claims a return on assets of 2.2%.
Accion International's total investment is $330 million, with an average loan size of $594 and a repayment rate of 98%. Of 24 projects in 13 Latin American countries and six US cities, 14 have already achieved self-sufficiency.
According to Accion's president, Michael Chu, it is market conditions, and not poverty itself which act as the real hindrance to the growth of small businesses in the developing world.
Speaking at a microfinance conference in London in June, Chu said the key to success was to treat the working poor as customers: "It is not a question of subsidy or benevolence. Microfinance is an economic activity and should be run to achieve self-sufficiency. Once this has been achieved and the costs of the project have been covered, the international financial markets can be tapped."
Microfinance will be lent new weight when the IFC enters the market. "We will be charging market rates on all loans, enforcing market discipline and we aim to generate a profit as well as meet all our costs," says Farida Khambata, director of central capital markets. "We are looking at several options for financing micro enterprises, including equity investment and securitizing the portfolios of microfinance institutions."
Miles Protter, executive director of debt capital markets at SBC Warburg, is upbeat about mainstream financial markets investing in microfinance institutions, although he has some reservations. "The main drawback is that the needs of most of these institutions are too small for debt or equity issues," he says. "A $5 million MTN deal of one to three years would be killed by the transaction costs, which could be as high as $300,000. Of course, an international bank might do it pro bono, but that would miss the point of establishing microfinance as a commercially viable entity."
In the long term, says Protter, the onus is on institutions which specialize in microfinance such as Banco Solidario to become more established. This will build up their credibility and facilitate raising capital. Chu of Accion suggests a two-to-three-year Eurobond medium term note placement as a suitable financing vehicle.
No one is expecting the international capital markets to accept microfinance quickly. First, microfinance institutions will have to become self-sustaining, and break free of the grants and soft loans provided by development agencies. But at last the attractions of microfinance are becoming clear to the mainstream investment community. Now it's just a question of who takes the plunge.
Antony Currie
PALESTINE
Need for laws and longer lending After the recent election which brought in Likud leader Benjamin Netanyahu as Israel's prime minister, Palestinian leaders are bemoaning what they believe to be the end of the peace process.
But Palestinian bankers regard political uncertainty as the least of their worries. Whether the peace process stands or falls, bankers in the West Bank and Gaza will continue with their efforts to establish an efficient banking sector. The lack of a central bank and of an independent currency are difficulties, but not a deterrent.
There has been much talk of a Palestinian currency but the scheme is unrealistic without backing in gold or other monetary reserves. For the time being, an independent Palestinian currency is unattainable in the West Bank and Gaza, where the Israeli shekel and the Jordanian dinar remain legal tender.
Palestine does have a monetary authority, but that is a misnomer. The Palestinian Monetary Authority (PMA) does no more than license and supervise the nation's banking sector.
The basic problems of the Palestinian banking sector are spelled out in a recent report on the reform of banking law in the West Bank and Gaza. "No laws have been passed by the Palestinian authority nor has it come up with an agenda yet," says Keith Molkner, the chief researcher of the report, which was funded by the US Chamber of Commerce and the Swiss government. "The PMA is still going through the stage of institutionalizing itself, formulating policy and regulations, and finding qualified supervisors."
In Molkner's view, one of the major difficulties for Palestinian banks is the low loan-to-deposit ratio. In the absence of legal mechanisms to enforce collateral lending agreements, only about 20% of deposits are granted as loans. Since the enforcement of collateral lending legislation has been very weak, the local banks' risk-adverse mentality appears to be justified.
Moreover the Palestinians are unwilling to cooperate with the Israeli authorities in cases of foreclosure on real-estate loans, and the Palestinian authorities are not organized to do the job themselves. Whatever lending was done in the past was effected via multiple guarantors of people with high social status. Today, Molkner says, the Palestinian population would offer a good deal of resistance to foreclosure because of their long experience of seeing land appropriated by the Israelis.
While the Jordanians have a lender of last resort in the Central Bank of Jordan, the Palestinians do not. Local bankers favour some type of legal protection or mechanism to monitor their lending practices and thus create a disincentive for poor loan/deposit ratios. Capital flight to Jordan and other Arab countries is another obstacle to the development of local banking. So far, over $1.2 billion in Palestinian-owned funds has been diverted to banks outside the West Bank and Gaza, with only a quarter of this sum contributed by Palestinians living or working abroad.
"This has undermined solvency and liquidity in the West Bank and Gaza Strip financial sector," says Haj Hashem Ata Shawa, chairman of the Bank of Palestine, a local commercial bank.
What the Palestinians need most, Molkner argues, is a unified banking law which would enable the PMA to exert its authority and to encourage lending which is crucial for economic development.
Shukri Bishara, regional manager of the Arab Bank, explains that Middle Eastern banks typically have a short-term deposit structure and prefer to offer short-term loans. Therefore the Arab Bank has decided to focus on long-term lending for industry, infrastructure and other projects which require a long-term repayment schedule."
The Arab Bank has also launched the Arab Palestinian Investment Bank, joining forces with the IFC and a German overseas development agency, Deutsche Entwicklungs-gesellschaft.
"This bank will focus primarily on medium to long-term lending, project finance, infrastructure finance and large-scale project finance," says Bishara. "Although these projects will be funded by lines of credit made available by the three major shareholders of the local banking branches, the majority of funds will come from the Arab Bank's reserves."
Issam Abu Issa, the chairman of the International Bank of Palestine, says his bank intends to establish special credit lines for agriculture, industry, and services. "Investors will have the choice to place their money in certain sectors. This bank will be the only one of its kind in the Palestinian-controlled areas to have these kinds of funds available to investors."
To fund its activities, the International Bank of Palestine will need capital of $20 million, of which $4 million has been contributed already. Eventually, 25% of total capital will be offered to the public.
One new institution is the Palestinian Construction Bank, which was established by the Palestinian Union of Contractors and will provide loans for construction and housing projects.
Although the Palestinian areas still have no central bank or currency, the governor of the PMA, Fuad Bseiso, claims to have achieved many of his objectives.
"The main priority of the PMA is to keep banking services open and accessible to the Palestinian people and organizations," says Bseiso. "The next most important objective is to support local banks so they can improve lending activities which directly influence the development of the economy."
Bsaiso aims to establish a system which makes the procedure of approving loans easier and more effective, and abandons the counterproductive routines which impede healthy loans. The PMA will also encourage commercial banks to invest more in long-term development and construction projects, in which case, "we have to cover for any gaps or shortfalls.
Joel Bainerman
BULGARIA
Last chance to reform Without the support of the IMF Bulgaria would have failed to service its debt payment of $1.2 billion this year, or so some international bankers believe. During the EBRD annual general meeting in April, rumours flew around Sofia that the host country was on the point of defaulting. So far the scaremongering has come to nothing. Now, with the help of a firm shove from the IMF, Bulgaria is making a more determined attempt to reform its economy.
The government finally began to address the economic crisis in May this year. Under pressure to continue debt repayments at all costs, it has worked out a comprehensive, 20-month programme of economic reforms. This joint effort by the Bulgarian government, the National Bank of Bulgaria and the IMF involves harsh measures - the closure or restructuring of loss-making companies and the liquidation or consolidation of many of the country's 50 banks. There will also be government spending cuts coupled with increases in taxes and levies to improve public-sector revenue.
Starting on July 1, the government will close 67 state companies - among them coal mines, refineries, power stations and shipyards - and restructure a second list of companies which includes Balkan Airways and the state railway company. The companies to be closed represent 20% of GDP and 27% of the accumulated bad debts of the banking system. Between 30,000 and 40,000 people will be made redundant from the shut-down companies and many thousands more could lose their jobs when the restructuring of the second group of companies begins.
Later this month the IMF is expected to sign a 20-month standby credit of $465 million which will support Bulgaria during this painful retrenchment. But it will be granted only if the closures actually take place.
The restructuring programme - which aims to limit annual inflation to 57% - should help to halt the steep decline in the value of the lev. Devaluation is a particularly serious problem because it drains Bulgaria's ability to make heavy debt repayments.
Bulgaria's foreign debt of around $9 billion is one of the highest per capita foreign debts in the region. To make matters worse, over $2 billion is owed in turn to Bulgaria by Iraq, Nicaragua, Egypt and Libya and is unlikely ever to be repaid. Iraq alone owes $1.2 billion, plus interest, which it was paying off in oil until the embargoes were imposed several years ago.
In 1994 a reduction of 50% of the $5 billion commercial debt was achieved with the London Club of bank creditors. Therefore, any subsequent default would be an extreme embarrassment.
This could be Bulgaria's last chance to find its rightful place in the economic pecking order of post-communist eastern Europe. Bulgaria lacks the infrastructure of 'top-tier' countries such as Poland, Hungary and the Czech Republic, but has a more advanced economy than most successor states of the former Soviet Union. The challenge is to remain competitive - in terms of price and infrastructure - with middle-ranking countries such as Latvia, Lithuania and neighbouring Romania.
The chaotic banking system is the weakest link in the economy. A sound banking law is not being fully implemented. A long-discussed restructuring programme designed to close or consolidate insolvent banks and strengthen supervision has faltered as politicians fought over the details.
As a result the banking system is still too unwieldy. After the deregulation of the banking system in 1992, there were as many as 80 banks. Consolidation has taken place since then: 22 banks have merged to form the United Bank of Bulgaria and 12 institutions have joined together to make the Express Bank in Varna. While the 80 old banks have been reduced to around 40, several new Bulgarian banks, plus six foreign banks - Dresdner-BNP and RZB Austria are two - have set up. This brings the new total to over 50: still too many for the central bank to monitor and control without difficulty.
Foreign-currency denominated government bonds are being given to old banks to boost their capital, but this assistance does not extend to sorting out problem loans, so the banks' fundamental problems persist. The banking sector has a negative net worth of around $1.3 billion.
Although a privatization scheme is in place, the sale of large state-owned companies has been extremely slow. Two major companies - the national telecoms company and Europe's largest soda ash plant - are selling 25% of their shares in a public offering. If transparent and fair procedures are followed during these sales, they may serve as a model for further large-scale privatizations and attract more foreign investors.
The question is whether, after four years of demoralizing drift, Bulgaria can push ahead with reforms. If the Bulgarians approach the new reforms wholeheartedly, then Bulgaria has a chance of being re-assessed by investors as a middle-ranking country. The next six months will be crucial. ]
Emma Rea |