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Debt Conversion Program: Guidelines for Bulgaria


There is a considerable theoretical and practical knowledge accumulated during the last decades. Learning from and applying this experience is imperative for Bulgaria. The main concern is that as many lessons should be learned as possible. Analyzing the experience of other countries, three sets of questions have been considered: those related to the authorization of the investment; the financial aspects of the conversion itself; controlling the negative aspects of the process, whilst maximizing the benefits.

There is also another important consideration to be kept in mind: it should be recognized that there is no single policy mix that can be followed blindly.

First, a significant legislative body with respect to foreign investments and privatization is already in place in Bulgaria.

Second, the restructuring agreement with the commercial banks already predetermines the debt instruments eligible to participate in a future Debt Conversion Program (DCP).

The priorities and preferences elaborated and adopted in the program are the outcome of a balance stroke between the already concluded agreement with the private creditors, the existing legislation and the economic goals pursued by the program.

On the basis of those aspects of the programs of Argentina, Brazil, Chile, and Mexico that have particular relevance for Bulgaria, a set of criteria that secures the backbone of the program was identified.

This set of criteria was discussed with our foreign consultant. It was the main topic of a special seminar held in Sofia. The participants represented the executive and legislative branches of the government, the Bulgarian private sector and the foreign investors in Bulgaria, as well as the academic circles. This wide forum allowed the project team to get better ideas and feedback on the most important aspects of the DCP.

The main objective of the discussion was to clarify those aspects of the future program that were indisputably appropriate for Bulgaria. Another important goal was to understand what were the reasons for the differences in the programs and the background economic and legal rationale for this. Bearing in mind the legal and economic framework that prevails in Bulgaria, we focused our attention on the main criteria that can serve as a backbone for a successful DCP.

1. Eligibility criteria applied to foreign debt for the participation in the DCP

The debt instruments are determined by the stipulations of the agreement concluded with the commercial banks. These are the discount bonds at their face value and the front loaded interest reduction bonds accepted at a 50 per cent at their face value.

2. Eligible participants in the program (national, foreign, resident, non-resident)

This is one of the most politicized issue. The Argentine program allows domestic companies or persons to participate. In Chile, Chapter 19 is designed to be used only by non-residents. It is interesting to note that Annex 4 of the Chilean Chapter 18 permits residents to make investments in existing companies under the higher incentives of Chapter 19. Mexican-owned foreign companies could participate in the Mexican swap program. Domestic investors have no difficulty in circumventing restrictions on their participation by establishing offshore dummy companies. Chile was successful in screening the applicants and not allowing round-tripping. But the restrictions apparently are not effective and create resentment and political opposition. Moreover, when the domestic interest rates are high and only short term financing is available, swaps may give the local companies access to long term financing at reasonable rate.

3. Exchange rate at which foreign currency debt is converted into national currency

This issue is covered in the Ordinance on the Terms and Conditions for Participation in Privatization be the Use of Bulgaria's State External Debt Bonds, Art 4, Para 2 (SG No.99 of 1994, amended SG No21 of 1995).

Usually, the conversion exchange rate depends on the country's exchange rate policy and is irrelevant for the Bulgarian program, because the introduction of any preferential rate would create additional undesirable distortions. By redeeming at the market rate but using an auction or a preset discount to regulate the amount of the incentive for the investor seems to be the most used practice.

4. Fees charged for the right to participate

Countries that have used this provision with the objective of increasing fiscal revenues have abolished it. There are no fees charged in Bulgaria as the participation in privatization by the use of Bulgaria is a part of the market privatization where Brady bonds serve only as a new payment mechanism.

5. Quotas or ceilings on the amounts to be swapped

This is a very important aspect of the program, if there is provision for exchanges of debt into local currency. In the case of Bulgaria it is not recommended. However, the Bulgarian conversion schemes limit the participation of the Bradies - up to 50% of the price of the privatization deal can be paid by Bradies, while the rest could be paid either in cash or by other financial instruments (privatization bonds to be issued upon the start of mass privatization, state long-term internal debt bonds).

6. Discounts, if any, at the time of conversion

To capture a larger share of the secondary market discount for the government:
  • Auctions should be used to set the redemption price of the debt.
  • Domestic participants should be allowed.
  • Fresh money requirement should be dropped.

7. Investments eligible for financing through DCP

  • For high priority areas that are relatively unattractive to investors, two different levels of incentives (set in auctions or administratively) could be used.
  • For projects with high development potential (for some border regions, for example) well-defined criteria should be find out for their selection (employment, agricultural or industrial restructuring, etc.)
  • Only export-oriented investments happen to be additional.

8. Case-by-case negotiations or public auctions for the right to convert debt

Using auctions to set the redemption value may give the government a larger share of the discount than applying administratively set rules or negotiations. Brazil which used auctions, captured a higher share of the discount than did Chile. Negotiations or administrative rules giving different redemption prices for investments of different priority for the government could be useful. However, if many priorities are included in the list, then the differences in incentives for investors would be small and will have no impact on investment decisions. If there will be one or two high priorities that are unattractive for investors, than a segmented program that gives a moderate incentive in the low-priority category and a very high incentive in the high priority sector, may be effective. Such segmentation could be achieved either administratively or by separate auctions. Another point in support of auctions is transparency. Although no government grants admission to the auction without prior screening or case-by-case review, auctions may reduce the possibilities for corruption and add appearance of an honest and fair process.

9. Fresh money, "matching funds" or restrictions on the proportion of an investment that can be financed through the conversion

Argentina is the only country that has in its program specific requirement for fresh money. Chile applied the fresh money requirement on a case-by-case basis.

This requirement may bring fresh money to the country, but it has no fiscal benefit for the government. Dropping it altogether may probably increase the price that investors would be willing to bid in the auction, thus increasing the share of the secondary market discount that the government can capture.

10. Applicable tax regime

In Argentina the amount of the incentive is subject to the regular corporate income tax. Mexico is taxing the gain at a rate of 30 % at the time of the swap. The origin of the investor might have specific implications (Japan taxes the gain, for an US investor it might reduce his liability to the Treasury). Any special treatment should be well determined. Applying the general provisions for foreign investments does not create distortions.

11. Restrictions on dividends and repatriation (schedule for capital repatriation and profit remittance)

All existing programs forbid the payment of dividends and/or repatriation of capital for several years - typically four years for dividends and 10-12 years for capital. Most non-bank users are committed to staying in the respective countries for the long term. The Bulgarian debt-conversion schemes impose some restriction: the transfer of the income earned from the Brady-bonds investment is not allowed for no less then four years and the transfer of the capital (the liquidation guota or the price obtained from the sale of the enterprise) is not allowed for no less than ten years. . In general, the limitations do contribute to improving short-term balance of payments

12. Institutional and operational set of rules

a) The institutional authority for the program has to be very clearly defined by the legal instrument governing the DCP - Ministry of Finance or Central Bank.

b) The legal instrument itself has to be convenient for operation and matching the legal framework in place.

c) The decision-making process should be well-defined and based on a permanent flow of information.

d) The operations - applications, screening, agency coordination, ex-post control of implementation and sanctions - should be well-structured and transparent to the public.

e) A mechanism for identifying the quality of investors should be established, including the information network abroad. In Chile the success of the program is also attributed to the very good Central Bank of Chile's network of correspondent banks.

f) The system of supervision of the whole process is of utmost importance.

13. Screening of the proposed investments

All governments have special screening procedures for the swap programs. However, the purpose and criteria of the screening differ from country to country.

a) for additionality (and preventing round-tripping)
The screening is effective even though it is bound to give less than perfect results. It should be done on an expeditious basis.

b) for priority sectors, regions or export-oriented industries.

Given the strong positive association of export orientation with additionality it is recommended that screening, auction or negotiation restrict swap programs completely to export projects and screening is more rigorous for non-export projects. Restrictions to new capacity creation could be counter-productive because of the strong link between initial swap-financed buy-out and additional investments. Some of the swaps for financial restructuring are used to retire debt that has been taken over by the Central Bank. These swaps are not inflationary and have less real resource cost to the host economy. (Chile had a good procedure and mechanism to screen applicants from dummy offshore companies owned by Chileans).

14. Continuity and stability of the program

A program for debt conversion takes time to mature, to become well-known and to gain investor's confidence. For this reason well-designed start and continuity are very important. It is evident from the outcome of the different programs that a stable and continuous program after one or two years of implementation starts to generate significantly more additional investments.


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