Aleksandr V. Gevorkyan – ��

The frailties of diaspora bonds

Aleksandr V. Gevorkyan — Thu, 04 Nov 2021 10:38:00 +0000

The interest in diaspora bonds�� sustained by the theoretical potential in poor economies by raising funds from expatriate communities, often labor migrants, living abroad.��At the start of the COVID-19 pandemic in 2020, as developing nations faced sudden reversals in capital flows, diaspora bonds to counter the international capital markets’ volatility.��A year later, the by the international institutional investors may prompt renewed calls for tapping into diaspora. But�� the alternative scheme so easily deployable?

Diaspora bonds are sovereign debt securities issued by countries appealing to the altruistic motives of their cultural and national diasporas across the world. Historically, there have been several attempts to leverage the diaspora premium, with Israel and India running the most effective .

In the early days of Israel’s statehood, the country turned to the global Jewish diaspora for support, establishing the Development Corporation for Israel (DCI) and formally asking for a public loan instead of a philanthropic gift. Since 1951, the DCI run diaspora bond program raised by mid 2021 , aided by a comprehensive outreach campaign. The initiative has helped open Israel to international capital with subsequently more diversified debt securities issuances, while offering its diaspora a unique investment instrument. The economic viability and technical flexibility of Israel bonds remains unmatched with for donations, contributions to pension funds, and other uses with small-sum subscription minimums. Channeling funds into a variety of infrastructure, energy, high-tech, and other projects, diaspora’s financing has been instrumental to Israel’s state-building from inception of the Israel Bonds program.

Unlike Israel, . India’s rapprochement with its multilayered global diaspora was in late 1980s introducing formal designations for Indians abroad (e.g., Non-Resident Indians, NRI) recognizing diaspora’s economic and cultural impact. India’s diaspora bond-like instruments included the India Development Bonds in 1991, followed by Resurgent India Bonds in 1998, and India Millennium Deposits beginning in 2000. The latter two bonds were restricted to the NRIs but all three were issued at times of India’s economic and political crises at below prevailing market interest rates (or “patriotic discount”—a characteristic of diaspora bonds term structure).

Elsewhere others bonds (e.g., Ethiopia, Greece, Kenya, Nigeria, Sri Lanka), albeit with minimal success. Matching either Israel’s or India’s programs has been a challenge, even in national crisis (e.g., Greece’s 2011 from its diaspora). Where the first issue may have been successful, follow up attempts failed lacking demand from diaspora investors. Instead, some have advanced smaller-scale mechanisms for diaspora’s financial involvement in local development (e.g., ). Yet, the idea continues to tempt policymakers (e.g., Armenia’s ).

Idiosyncrasies of a developing country’s macroeconomics and financial markets aside (which technically should not matter by design in an altruistic diaspora investment scenario), in Israel and India is the treatment of the embedded misconceptions about three frail, yet, critical categories—diaspora, remittances, and trust—revealing uneasy diaspora and home country relationship.

First, not all migration leads to a monolithic diaspora that acts in unison towards its ancestral home. A confirms the non-linear multilayering of socio-cultural factors of diaspora self-identification, compounded by generational and geopolitical splits. Diaspora then is a dispersion of people, ideas, motivations, and transnational identities in historical continuum. Neither cultural similarity nor semblance of altruistic motives guarantee a diaspora bond effectiveness, as both Israel and India realized in community-tailored adaptations of their programs.

Second, while potentially critical for alleviating extreme poverty, remittances sent by labor migrants to their families are individualistic and susceptible to the host economies’ business cycles, with at home. While diaspora bonds, if successful, may indeed become meaningful instruments to fund development, neither the small sums nor the temporary nature of remittances are stable financial sources for a debt security in the unforgiving international markets. The reputational damage to the issuing country is too significant to bank on remittances or single contributions from affluent diaspora individuals. Capturing collective potential of remittances, a more migration-focused entity streamlining small scale transfers into infrastructure and development, e.g., , may be a better alternative.

Lastly, the above observations are compounded by a mix of political, cultural, social, and other aspects of mistrust, accumulated over generations of disconnect and lacking certainty in domestic matters, between home country and its diverse diaspora. Therefore, establishing sound frameworks fostering and strengthening mutual trust, may serve as a necessary step for home-diaspora engagement infrastructure prior to piloting a new debt instrument, even if structured to reach a retail diaspora investor. A possible application of such structure in the diaspora bond context may be a – a mixed group of fund managers, business professionals, and regulators from diaspora and home country overseeing the diaspora borrowing program.

For structurally weaker developing nations, a sufficient condition may be to explore non-conventional alternatives such as, for example, issuing diaspora . Funding local economic development in an environmentally sustainable way, with diaspora green bonds, may provide a transparent and socially responsible financing vehicle accepted by the risk averse diaspora. Learning from experience and exploring such pragmatic innovative solutions, may help to resolve the frailties of diaspora bonds leading small economies to finally meaningfully capturing the elusive diaspora premium.

Aleksandr V. Gevorkyan, Ph.D. is the Henry George Chair in Economics and Associate Professor of Economics at The Peter J. Tobin College of Business at St. John’s University. He is the author of (Routledge, 2018).

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How History Matters in Post-Socialist Economies

Aleksandr V. Gevorkyan — Wed, 01 Aug 2018 20:03:17 +0000

Though it has been suggested that ‘ it was in the early 1991 that captured the minds of the new generation of Eastern Europe (EE) and the Former Soviet Union (FSU).

The promise of more open societies following Mikhail �Ҵǰ��’s perestroika announcement set in motion powerful dynamics completely transforming the world. The Berlin Wall fell in 1989 and by the end of 1991 the Soviet Union disintegrated bringing down the entire socialist institutional edifice. Newly independent nation-states emerged across Europe, the Caucasus, and Central Asia. This new “wind” was that of hope, progressive stability and economic prosperity, or so it seemed at the time. And yet, “[��]or whom the wall fell?” , is not as straightforward as might have been expected.

Despite the independence premium in national policy and in parallel with the post-socialist economies are yet to achieve the ideals announced at the outset of market reforms. Ironically, the most unfortunate economic plan was the 1990s script of transition from planned economy to free market in the EE and FSU.

Economics first

Back in 1980 EE and FSU economies collectively represented up to 15 percent of the �ɴǰ��’s economy, in gross domestic product (GDP) shares (Figure 1). By 2016, this same group barely claimed 6 percent of the global output share. The largest economy in the group, Russia, averaged 3 percent of the global share in 2016, with remainder going to the smaller FSU and EE economies.

Figure 1. Eastern Europe and Former Soviet economies’ relative to the global GDP, % shares.

Source: author’s estimates based on (original analysis is aggregated in )

Granted these are approximate estimates, subject to statistical revisions, and will change as global commodities trade and geopolitics play out, the decline from the socialist highs to the post-socialist lows of the ��ǳܱ�’s global economy ranking has been drastic. On a macro scale GDP levels across majority of countries would only rise back to the 1989 levels by late 1990. In many cases this would not occur until the mid-2000s (e.g. Armenia, Bulgaria, Croatia, Romania, and others). And as of 2017 measurements, for some countries such as Georgia, Moldova, Serbia and Montenegro, and Ukraine, broad GDP levels are yet to come back to pre-reform levels.

The macroeconomic trinity reforms of liberalization, privatization, and stabilization were the tangible triggers of the change. The choice was made to reform quickly, abruptly severing all ties from the socialist past. Poland’s Deputy Prime Minister, Leszek Balcerowicz offered most convincing motivation, exclaiming that Poland was The refrain would influence practically all EEFSU policy makers.

The adopted macroeconomic policy packages called for rapid dismantling of the existing economic (and political) system paving the way to the rise of private enterprise and competitive market institutions. The collapse of the socialist common market () led to a breakup of established supply lines across the region, most severely affecting the smaller FSU and those in Southeast Europe economies. At the same time, macroeconomic research analyzed the timing, sequence, and intensity of reforms (e.g. ). This turbulent economic policy whirlpool gave rise to the infamous “shock-therapy.” Social costs were deemed to be collaterally minor as opposed to a greater goal of economic prosperity (what an odd parallel to the goals of the socialist past).

The reality

There is hardly any need to re-tell the known story. Those EEFSU economies with significant dependence on the CMEA suffered the worst macroeconomic and social impacts in the early years of transition. While the early declines in industrial growth and productivity might have been expected, hardly anyone foresaw the massive economic and social degradation at the time.

Figure 2. Real 2000 and 2016 GDP per capita by country (1989=100)

Source: author’s estimates based on (original analysis is aggregated in )

estimates real gross industrial output collapsing between 1989 and 2004 up to 80.2 percent in Georgia, 74.2 percent in Albania, 52.8 in Kyrgyzstan, 45.6 in Romania, 35.6 in Bulgaria, 32.8 in Armenia, 28.7 in Russia, and similar ranges elsewhere. Despite the general negative trend, there were some notable exceptions. For example, Belarus, instead, saw an increase of 41.2 percent over the same period in its real industry growth, while most of the Eastern European economies, now members of the European Union, overcoming immediate losses induced by the breakup of legacy trade ties and under the stress of shock therapy, have posted steady growth starting in mid 1990s and up to now.

More concretely, only a handful of countries reached the 1989 per capita income levels as of 2000 as can be inferred from Figure 2 contrasting GDP per capita levels of 2000 and 2016 to the pre-reforms, 1989, level. Interestingly, economies either strong European Union integration (or relying on other development transfers) have performed better. For some countries, Ukraine, Georgia, Tajikistan, etc., the 1989 income levels as of 2016 estimate still remained out of sight on per capita basis. Per capita numbers are adjusted for population changes. Considering large scale migration out of these countries, the macroeconomic landscape outside of the large central city becomes loses some of its gloss. What is not obvious in this contrast, often portrayed as the success of shock therapy, is the factor of initial economic conditions, in particular in some Eastern European countries.

For example, the Czech Republic, Hungary, and Poland would be the most industrialized in the group, as evidenced in monumental archival work by Wlodzimierz Brus in larger study by ��(1986). Post-World War II investments into heavy machinery and consumer products industries reached close to 50 percent (and in some places more) of the total, with remainder going to agriculture and services. Coupled with relatively loose controls (in contrast to FSU) over trade connections with Western Europe, industrial growth with newer technology set the EE countries on a more advantageous footing vis-à-vis their Soviet “peers.’ Furthermore, agricultural sector, despite nationalization attempts, in EE sustained significant private ownership, unlike in the FSU. Finally, majority of the EE economies were able to tap international capital markets, mustering some investment in upgrading their capital funds and technology, despite getting into debt and eventually opting for International Monetary Fund bailouts (e.g. ).

As life expectancy dropped by mid 1990s, either due to retraction of state provided basic healthcare services, military conflicts, or under psychological stress of dealing with uncertainty of survival, unemployment skyrocketing as state-funded enterprises collapsed, and hyperinflation pushing societies in the Southeast Europe and parts of the FSU into barter transactions, income inequality and wealth inequality began to �ɴǰ��as well. Desperate to flee from jobless growth conditions (a term used by the ), military conflicts, migration, , climbed to recent history highs, exacerbating population losses from Bulgaria, Moldova, to Armenia, and to Tajikistan. For some of these countries remittances, the small monetary transfers that migrants send back home to support their families, have become instrumental to every day survival, . These transfers continue to play an important financial supporting role across mostly rural communities in countries lacking institutional structures channeling remittances towards economic development initiatives (though some proposals suggest a to serve the purpose).

Institutions will come along

Continuing with the concept of initial conditions there is a duality: economic base and less tangible institutional development.

As mentioned above, the economic footing of the region varied, more favorably for the industrialized EE economies and less so for the CMEA dependent FSU, other than the larger commodity exporters in the group. suggesting that by the early 1980s the declining investment in industrial and technological upgrades, much necessary for the competitiveness of the EE’s semi-open economies, largely caused the growing inefficiency of those economies preventing wide-scale adoption of labor augmenting techniques, in contrast to the early 1950s post-war rapid growth. A similar argument is found in an earlier study by of the Soviet Union by by the early 1980s as a major critical factor worsening the subsequent 1990s recession. Both observations, could be argued to be in parallel with the as a possible conceptual framework in the post 2008 crisis analytical and policy work.

Of course, the unexpected element in the 1990s reforms was the dominance of the evolutionary and transformative nature of institutional development. This leads to the other side of the mentioned duality. There is no lack of relevant research in the problem of institutional change (e.g., ; ). In the post-socialist context, the problem of the 1990s transition policies was standardization across macroeconomic and evolving institutional change, in absolute dissonance with country specifics.

A set of collected studies edited by annotates the subsequent trajectories of the resulting non–‼��ܰ��”-market outcomes. More recently the institutional literature has seen new researchers calling for more country specific analysis in economic reform as opposed to over-simplified one-size-fits all approach of “bundles” or “types” to economic systems (e.g. and ). More substantially, Yegor Gaidar—the architect of the 1990s economic transformation in Russia—offered a sober analysis in one of his last contributions (), recognizing the socially disruptive nature of the 1990s institutional vacuum.

New institutions lacked foundational traditions and required a long time to evolve—this realization is at odds with the predominant “reforms first” views of the early transition era. Still, Gaidar’s argument appears to be consistent with definition of institutions as “the rules of the game in a society.” Here society at a given time is the outcome and the driver of an evolving web of accumulating institutional tendencies. This necessarily implies gradual institutional emergence and adaptation to the new social norms and business practices, as the dynamic self-regenerating process of economic development takes over.

An emerging new concept of “varieties of capitalism” (; ; ; ) seems to be capturing researchers’ imagination. Complementing the debate, discuss varieties of communism, suggesting the influence of an even more complex mix of individual and nuanced social motivations rather than an all-encompassing institutional change. The former approach may help explain better the diversity of post-socialist economic models. Certainly, the question of the final destination must be openly discussed.

And still, in a recent , Eshe Nelson raised much concern about sustainability of strong economic growth and progressive social change in the region. Strikingly, perhaps to some observers, the reference is in to the top EE performing economies. For example, the author draws attention to unsustainable government spending in Romania or rise of populist business people in Czech Republic elsewhere; often disconnect between policy intentions of Poland (e.g. judicial reform) and the European Union, and other examples. In fact, Ivan Berend, an authoritative name in the field of transition economies, voiced strong reservations in his 2009 From the Soviet Bloc to the European Union over the haste to declare absolute victory [in “transition”], citing large population displacement and rising social pressures, often unintentionally masked by the rapid economic growth mainly dependent on the . From Southeast Europe to Caucasus and Central Asia, the smaller is the country the stronger is the challenge of securing broader economic activity, attracting competitive foreign direct investment, avoiding underdevelopment, and sustaining social inclusion; all without falling into dependence on the earlier mentioned expatriate remittances feeding into consumption cycles or significant levels of debt pile-up.

Why is this important now?

Still, there can be no doubt, today post-socialist societies of Eastern Europe and the former Soviet Union live in a more open cultural, political, and economic environment. The civil, political, and economic freedoms enjoyed by the region’s citizens are unprecedented in the scope of the twentieth century (and perhaps even earlier) offering much hope for continued progress in economic and social development. However, analysis of the causes of the 1990s massive economic losses and degradation of the living standards must necessarily be connected with the dynamic history of the region.

In broader context, the market liberalization reforms were the signals triggering a more systemic disruption, in turn exacerbated by the disparities of the preexisting conditions of the socialist economic model of the time.

Perhaps one of the difficulties for a nation is to become content with its own history. This is less so about repeating history but more about ability to objectively settle the past discontents to seek pragmatic balance of the present. These challenges are visible across the post-socialist geography, from Central Europe to Caucasus and Central Asia.

As for the future, it is by definition bright, progressive, and prosperous, which seems to be a unifying end goal here (as it naturally should be, perhaps).

And so while the past remains debatable and difficult to accept, while the future is full of promise, the present remains important as ever.

History teaches that to move forward, much attention should be given to the complexity of country specifics, regional dynamics, and, unsurprisingly, history itself. This, perhaps, would be the most critical lesson one is to draw from the late 20th century massive transformation of the societies and economies of Eastern Europe and the Former Soviet Union as it is relevant to contemporary macroeconomic and institutional processes.

It is tempting to find salvation in a rapid action. Perhaps, under certain conditions it may even be the right approach. Yet, from a social dialectic a more evolutionary approach might be more prudent instead.

Just how the individual ‘transition economies’ interpret this lesson in their present conditions will no doubt shape their future.

Aleksandr V. Gevorkyan�� .��He is also the author of .��

Transition Economies: Transformation, Development, and Society in Eastern Europe and the Former Soviet Union is available via as well as for and .

How We Learned Not to Say No to Gold… In International Reserves

Aleksandr V. Gevorkyan — Mon, 12 Mar 2018 21:21:03 +0000

By Aleksandr V. Gevorkyan (St. John’s University) and Tarron Khemraj (New College of Florida)

In May 2016, economist Kenneth Rogoff that central banks in emerging markets should add gold to their reserves. Rogoff stated “that a shift in emerging markets toward accumulating gold would help the international financial system function more smoothly and benefit everyone.” Despite initial disagreement, we find there may actually be some justification for this view in a recent .

Until recently, literature on the optimal composition of foreign exchange reserves could be divided into two groups. The first focused on demand for reserves for transaction purposes (, , , ). The second, using a Markowitz-type portfolio approach, studied currency composition of optimal foreign reserves (, , ). On a more general level, some studies offer more comprehensive discussion of factors determining the optimal level of international reserves (e.g. ; ).

Instead, we develop an analytical model that allows for estimation of the shadow price of the target exchange rate, which is interpreted as the central bank’s sacrifice of policy precision given additional unit of portfolio variance or return.

This means that while we explicitly assume that central banks in emerging (and frontier) markets target exchange rate stability, there may also be competing pressure to maximize portfolio returns based on the international reserves mix.

To be sure, gold is not a new asset to central banks’ portfolio, neither historically, nor recently (Fig 1.). However, there has been a steady decline in gold holdings as central banks shifted towards a hard currency (e.g. U.S. Treasuries) mix of reserves. The low income and middle income economies have lowest shares with minor increases in the post-2008 years.

Figure 1. Percent of gold in central banks’ foreign reserves by country group.

Source: authors’ estimations based on data from the IFS (2017) and WDI (2017).

In the years before the 2008 Global Financial Crisis (GFC) both volatility of gold and U.S. Treasuries declined (Fig. 2). Gold dropped off first, rising momentarily, and then stabilizing. U.S. Treasuries followed, but on balance both assets may be seen as safe havens given their lower volatility during the GFC.

Figure 2. Estimated volatility of gold and U.S. Treasuries, 2005 to 2012

Source: authors’ estimations based on data from FRED (2017).

In a simulated local economy in our paper, there may be range of preferences (and perceptions) towards currency depreciation (or policy devaluation) and appreciation, expressed by θ_1 and θ_2 respectively, given the central bank’s holdings of foreign reserves relative to the policy target. In many small open economies θ_1 would tend to be greater than θ_2 reflecting the higher aversion to devaluation. At the same time Π is the foreign exchange market’s expected subjective or calculated short-run probability of depreciation or devaluation.

The central bank’s exchange rate target – that requires foreign reserves balancing – is constrained by (i) the volatility introduced by adding gold to the portfolio of reserves; and (ii) a weighted reaction function that combines both portfolio variance and return. Some central banks might also want to manage foreign exchange reserves subject to returns (e.g. Pina, 2017).

The central bank is assumed to react negatively to volatility and positively to returns. In the model this is captured by Ψ which takes values between 0 and 1. If Ψ =1, then the monetary authority is completely in the corner of the precautionary motive as it targets the exchange rate. On the other hand, if Ψ =0 the central bank is completely focused on returns as it pursues the exchange rate target.

As such, we construct a model capturing domestic foreign exchange market, adding gold demand constraint and analyzing the policy sacrifice shares in two regimes. The first, which we define as precautionary case, focuses on maintaining a currency target rule. The second, which we define as a hybrid case, adds central bank’s considerations for both portfolio variance and returns.

A representative central bank seeks to choose a level of gold that minimizes the loss function subject to portfolio volatility and some combination of volatility and returns. In other words, we want to choose a percent share of gold WG when the policy sacrifice (λ) is at a minimum when takes values from 0 to 100%.

We are also interested in whether the range of values increases or decreases sharply or gradually. If the sacrifice value is increasing or decreasing slowly, one could conclude that it is possible to demand gold over the said range without significantly preventing the central bank from achieving its exchange rate target.

Our simulations (Fig.3 reports example of the Hybrid Case) indicate possible existence of a two-regime demand for gold. In policy terms multiple equilibria suggest the monetary authority possibly has a wide percentage range of gold demand.

Figure 3. Hybrid Case: returns and volatility constraint for Ψ =0.8

In Figure 3 the weight reflecting the central bank’s preference for precaution is higher at Ψ =0.8. The sacrifice values on the vertical axis are smaller. The conclusion here is that if the central bank is motivated by the precautionary motive, then an exchange rate target could be consistent with about 45 to 60 percent gold reserves in the portfolio without significant loss of policy sacrifice, assuming that the economy possesses the given parameters. In the hybrid case, a higher probability of devaluation causes the curve to shift downward and expand the range of possible gold percentages. This suggests that central banks have a range of gold shares to opt for with somewhat minimal sacrifice in exchange rate target policy precisions.

The overall conclusions suggest there is some justification to the original view of adding gold to the central bank’s reserves in emerging and frontier markets. Demanding a higher percentage of gold is more appropriate if the central bank prefers to accumulate international reserves for precautionary reason. At the same time, the central bank would tend to incur greater exchange rate target sacrifice if it wants to achieve higher portfolio returns. Our estimations suggest that ability to target the exchange rate is unaffected by the higher volatility of monthly returns on gold. That in turn suggests that gold might be replaced with another safe asset with similar characteristics.

The latter observation, opens up a much greater range of monetary policy flexibility to the countries susceptible to externalities from global capital flows and lacking strength in the domestic currency.

References:

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FRED (2017) FRED Economic Data. Online Database. St. Louis, MO: Federal Reserve Bank of St. Louis. Available online:

Gevorkyan, A.V. and T. Khemraj. Forthcoming. . Emerging Markets Finance and Trade.

Heller, H. R. and M. Knight (1978) “.” Essays in International Finance, No. 131, Princeton University.

IFS (2017) International Financial Statistics. Online database. Washington, D.C.: International Monetary Fund. Available online:

Ito, H., R. McCauley and T. Chan (2015) “.” Emerging Markets Review, 25, 16 – 29.

Papaioannou, E., R. Portes and G. Siourounis (2006) “.” Journal of Japanese and International Economies, 20, 508 – 457.

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Aleksandr V. Gevorkyan is Assistant Professor of Economics at St. John’s University and Tarron Khemraj is Associate Professor of New College of Florida.

Aleksandr V. Gevorkyan – ��������