Dog bites man, East Timor loans money to Portugal

 Yesterday, the government of East Timor announced that it would purchase $700 million in Portuguese bonds. (Hat tip: Randy McDonald.) At first glance, that seems kind of stunning. One of the poorest countries on the planet is lending money to a member of the European Union? It sure looks like “an interesting inversion of the standard postcolonial paradigm.”

At second glance, there is a story here, but it isn’t the one you might think. The story is that East Timor is handling its oil boom quite responsibility. The rest is unsurprising. Let me start with the unsurprising part.

First, capital flows from oil-rich ex-colonies to their former metropoles are nothing new. The UAE, Qatar, and Bahrain have been investing a lot of money in the U.K. for quite some time. The nations of French West Africa hold a minimum of 65% of their foreign exchange at the French treasury (and in practice rather more) in essence lending money to the metropole. In fact, such capital flows predate independence: Britain hung on to the sterling zone for a long time because it feared that its colonies would no longer lend to the U.K. without it.

Second, Portuguese bonds are a pretty good investment. The 10-year bond is yielding 6.7% — that’s 2.7 times the yield on German bonds. Unless Portugal repudiates past-due interest payments (and in postwar debt restructurings, only Argentina has done that) bondholders would come out ahead as long as the haircut on debt principal is less than 25%. (To be fair, the math is a bit more complicated, because it depends on when Portugal defaults, but that serves to make the bonds more attractive.) In other words, the East Timorese deal is far from charity.

Third,the purchase has the obvious additional benefit of buying some Portuguese goodwill, which ain’t nothing, considering that Portuguese aid averaged €42.6 million per year between 1999 and 2009. Moreover, Portugal has been cutting foreign aid significantly, so buying goodwill could have a big return. Considering that East Timor will earn €34.4 million per year on its investment, that is a pretty cheap way to buy goodwill.

From Portugal’s point-of-view, however, there is no charity. First, the loan is a drop in the bucket compared to the country’s total debt of €145 billion. Second, the loan is being made at commercial rates, and will involve buying existing sovereign debt, not the provision of new money. Third, it might not all involve Portuguese sovereign debt: the Timorese authorities have added the following weasel words: “Investments could be made in highly successful public or quasi-governmental enterprises that guarantee high returns.” Considering that $700 million is a legal maximum for East Timor, which has to invest 90% of its assets in U.S. Treasury bonds, the implication is that the Portuguese government will get less than that.

In other words, Portugal will get a small amount of help from a source with every incentive to lend it money regardless of political connections. (I suppose East Timor could buy Greek bonds instead.) Not much to feel grateful about. Portugal probably will anyway. That isn’t a bad thing. But it doesn’t make this loan into any sort of new post-colonial paradigm, or give Portugal a serious lifeline. It is, sad to say, a sideshow. Dog bites man.

 

The real story is that East Timor has the money to invest. Why? Simply that since 2004, most of the country’s oil revenues have been placed into a fund and invested overseas. On average, 82% of revenues have gone into the fund, and never less than 74%, in 2006. (See the above chart.) Considering that Gabon, for example, has made a complete hash out of a similar fund, as have many other countries, that is an impressive achievement. other countries haven’t even tried. (It would be churlish to suggest that the extreme level of foreign influence over the Timorese government has anything to do with the success.)

 

In the long-run, East Timor is guaranteeing itself a perpetual income around $500 million per year, which isn’t bad for a country of only a million people, although population growth will reduce the per-capita value of that benefit over time. (That’s the shrinking dashed line in the above chart, which assumes $60 per barrel oil.) It won’t solve the country’s many problems, and it may be invested too conservatively (90% in U.S. treasuries? Really?) but if the Timorese government can stick to it, then the oil discoveries have a good shot at promoting the nation’s long-term good. That’s the big news, not the decision to invest in Portuguese sovereign deb.

Comments

[nigel]

the real value will also decrease, right?

[Noel Maurer]

Absolutely.