[LINK] "Dog bites man, East Timor lends money to Portugal"

[rfmcdonald]

Over at the Power and the Money, Noel Maurer convinces me that the East Timorese purchase of Portuguese debt actually makes sense from a business perspective.

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.

[. . . 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.

At least noteworthy is the fact that East Timor has the money to invest, having put its oil revenues in a well-managed investment fund. If I read Noel correctly, moderate optimism about the long-term future of this fund--and, one may infer, East Timor--is justified.