Question

Twenty-four low-income countries have issued foreign-currency bonds since the year 2000, raising $135 billion. Zambia, a landlocked country, has accumulated foreign debt of $11 billion. The borrowed funds were targeted for building infrastructure, fighting disease, and educating children. In 2019 Zambia earned $6.9 billion from its exports, 73% of which came from copper. From 2000 to 2008 the price of copper increased from 67 cents per pound to $3.89 per pound, in part due to demand from China. Zambia's GDP is valued at $27 billion. (18 points) Analyze and discuss the advantages to Zambia of issuing foreign currency bonds. Analyze and discuss the risks to Zambia of issuing foreign currency bonds.

Answer 1

Advantages to Zambia of issuing foreign currency bonds-

1. Low cost funding - Usually funds from foreign countries comes at lower cost of funding, therefore this money can be spend with a long term horizon perspective in activities like infrastructure, education etc.

2. Sufficient availability of foreign currency - As Zambia's 26% of GDP is dependent on exports, it must has accumulated sufficient foreign exchange reserves to serve debt denominated in foreign currency.

3. Strong incentive not to default - It has been seen in the past there is good incentive for borrowers not to default on their foreign debts, therefore this will build creditworthiess of Zambia in long run.

Disadvantages of Zambia of issuing foreign currency bonds-

1. Potential to multiply damage from financial crisis - At the times of financial crisis, usually local currency value of emerging markets goes down. This will result in increase in the value of foreign currency debts and thus increasing financial burden on Zambia.

2. Foreign exchange shortage - If there is foreign exchange shortage happens, then government cannot print foreign currency. This shortage of foreign funds may lead to default on Zambia's foreign currency liabilities.

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