Can Perpetual bonds provide some relief against economic effects of COVID 19 pandemic ?

corona and economy

Recently Spain submitted a proposal on perpetual bonds ahead of European Council’s virtual summit on April 23 to discuss European Union’s response to the economic downturn caused by COVID-19 pandemic. With a similar opinion, George Soros, the well-known American billionaire investor and hedge fund manager, suggested that EU should issue perpetual bonds to finance the proposed European Recovery Fund of €1 trillion.

In India, Rathin Roy, the director of National Institute of Public Finance and Policy has opined the same remedy to deal with the current situation.

So what are Perpetual Bonds?

These bonds are forever like diamonds. Just kidding :).

Issuing a bond is one of the ways of raising money by the government or a bank. This can be seen as an extension of loan to the government/bank by the investor. In a perpetual bond, also known as “consol bond” or “prep”, there is no obligation to repay the principle. The bonds have no maturity date. This is why it is considered more of an equity rather than a debt. And equity refers to the stake of a shareholder in any entity.

Now, the question arises that wouldn’t the government incur a loss if it decides to pay the interest in perpetuity. Well, that can be avoided in following 2 ways-

  1. By keeping the interest rates extremely low in the long term. Especially when the inflation is high, the investors usually lose money. For instance, if a person is receiving an interest rate of 0.5% on a perpetual bond, the final rate of return may end up to be -0.5% or -1% if the inflation rises to 1 or 1.5% respectively. In order to have a profitable investment, the rate of return has to keep up with the rising inflation, which is not possible as inflation is a definite phenomenon to occur in long run.
  2.  With the passage of time, higher interest rates can be offered by other  investment options compared to a perpetual bond bought, let’s say, 50 or 100 years ago. Considering these factors, there are good enough chances for an investor to lose money in a perpetual time frame.

Nonetheless, perpetual bonds have been used in the past like the British government in the 18th century to finance Napoleonic and Crimean Wars, and United States in 1870. In January 2019, Chinese government approved first ever issuance of perpetual bonds by the Bank of China in an attempt to recapitalize banks and boost economy.

So is it possible to revive economy with perpetual bonds ??

hunt-for-yields-leads-traders-to-perpetual-bonds-of-large-banks.
Credit-Economic times

Based on the above precedents, perpetual bonds are lately being advocated against pandemic-induced recession for the three major advantages they offer-

    1. There is no obligation to pay back the principle especially when the governments worldwide are fiscally constrained.
    2. Following from above, the bonds have the effect of not raising the public debt.
    3. Politically, the government wouldn’t need to go through a time-consuming process of parliamentary approval; hence, these can be issued on emergency basis.

Are these bonds the way forward ??

First of all, an immediate issuance of perpetual bonds, rather than as last resort, is more effective in arresting further economic downturn. In an expectation of future financial hardships, a major section of middle class having the capital to invest in bonds, has fallen into precautionary savings.

An option of pandemic-specific perpetual bonds would allow people to incentivize this saving behavior while solving the problem of funding for government.

Secondly, the fixed income security received from these bonds would also provide a steady source of income which when spent will keep money circulating in the economy.

Thirdly, since Covid-19 is a typical black swan moment (A black swan is an extremely rare event with severe consequences. It cannot be predicted beforehand, though many claim it should be predictable after the fact) .and has generational implications, issuance of perpetual bonds would allow distribution of monetary shock over generations, thus, easing the burden on current population.

And based on the need of the situation, these bonds can be designed accordingly and their specified use can be notified to the public. Overall, perpetual bonds have all the potential to bring at least temporary relief in these troubled times.

 

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