By Stephan Haggard
According to a story in DailyNK by Jang Seul Gi, the North Korean government has taken the initiative to issue government bonds; several astute analysts of the Korean economy have picked up on the story (Tom Byrne at Foreign Policy here and Benjamin Katzliff Silberstein at 38North here). As with all such stories, we need to take it with the appropriate grain of salt. Nonetheless, the particular details reported by their informants are highly plausible. The episode provides another piece of evidence that the regime is coping with significant financial distress from the combination of sanctions and the economic effects of the border closures with China as a result of COVID-19. And it is also likely to show that as in the past, this distress is going to lead to a struggle for resources between the regime and the private sector.
Before turning to the lessons from earlier bond issues in 2002, it is important to underscore that the bonds in question are domestic bonds, and not the highly-speculative packaging of North Korea’s foreign obligations that sometimes makes the news. North Korea participated in the wave of foreign lending to developing countries during the 1970s, drawing on loans and lines of credit from at least 30 institutions. But by the late 1980s it became clear that the regime did not have either the capacity or the willingness to repay. As Tae-jung Kim has detailed in a useful overview, exotic debt markets responded to the interests of bottom-trawlers. Rather than continuing to hold the debt on their books, creditors sold the rights to collect North Korean debt to the French bank BNP Paribas, which later launched derivative bonds under the moniker of the “NK Debt Corporation.” Although the bonds are basically worthless, they have periodically seen price movements during periods of optimism, particularly when progress on the nuclear issue seemed possible.
There is one deep underlying similarity between the foreign bond saga and the current bond issue, however: that the North Korean regime faces enduring credibility problems that fundamentally limit its capacity to raise funding through the issue of debt of any sort.
The government first issued domestic bonds in 1949-50 to fund the war effort; it is doubtful that these borrowings were repaid. In Famine in North Korea, Marcus Noland and I discussed the issue of government bonds during the 2002 economic reform effort, an episode that provides a useful lens on the current effort.
The purpose of the July 2002 reform was largely to ratify processes of marketization that had taken place during the famine. The effort had four central components: microeconomic policy changes with respect to both industry and agriculture; macroeconomic policy changes; and renewed efforts to create special economic zones and secure foreign aid.
The macroeconomic component of the reform included an ill-designed price reform that ended up producing rampant inflation, an inflation which had the consequence of devaluing the cash holdings of traders and households. With the central plan crumbling and the government unable to raise new revenue through a transaction tax, in March 2003 it announced the issuance of “People’s Life Bonds.” The government’s announcement stated, without irony, that “the bonds are backed by the full faith and credit of the DPRK government,” but they more closely resembled lottery tickets. The bonds had a 10-year maturity, with principal repaid in annual installments beginning in year five. However, there did not appear to be any provision for interest payments. Rather, for the first two years of the program the government would hold semi-annual drawings (annually thereafter) with winners to receive their principal plus “prizes”; in effect the payment of interest appeared a matter of pure luck. Needless to say, the purchase of the bonds was not altogether voluntary, as committees were established in every province, city, county, institute, factory, village, and town to promote their sale as a “patriotic deed.” Such efforts were hardly popular, as they amounted to little more than a new tax.
The details provided in the DailyNK story—if true—comport with this earlier episode but with a few interesting twists. The issue was apparently ratified during the Politburo meeting of April and clearly reflected fiscal distress: as Byrne points out, the Minju Chosun called on factories and businesses to fulfill their tax obligations, a clear indication that they were not in fact doing so. The bonds were apparently printed by mid-month and ready for sale (although we do not have any further information at this point on the progress of their sale).
An interesting twist is that they are not only targeted at households, but are to be used by organizations—say, Construction Bureau 8—to purchase materials from state-owned enterprises. My interpretation is that this effort to substitute bonds for cash is designed to avoid direct monetary emission that would have inflationary effect or lead to a depreciation of the exchange rate. Unlike the advanced industrial states, and even emerging markets, monetary policy is hard to conduct in the North Korean economy, where there are no functioning financial markets. Who wants to hold more North Korean won?
However, what the coverage of the event demonstrates most clearly is that a government completely lacking in credibility is unlikely to be able to manufacture it on short notice. As the DailyNK story notes, both high-level regime officials and the donju class are starting to hoard US dollars. The reason is simple: they rightly see the bond issue as both a sign of distress and as a signal that a crackdown on markets could be coming, as the state scrambles to extract real resources from a struggling economy. The reporting of the DailyNK again lines up with economic expectations. In the absence of any trust in government, the Ministry of State Security (MSS) has mobilized teams to crack down on informal markets for foreign exchange, a clear indication that bond purchases will effectively be imposed on unwilling buyers and suppliers.
I have long predicted that the North Korean economy is vulnerable to an old-fashioned balance of payments crisis as it is unable to finance its ongoing deficit with China. I have consistently been wrong because of hidden reserves, Chinese foreign investment and aid, and probably arrears to Chinese suppliers. All of those factors may once again save Kim Jong-un, but we should again be monitoring the exchange rate. Recent movements show some short-run depreciation in black market prices for the dollar, but not out of line with prices since the first of the year. Nonetheless, the bond issue episode is a telling sign of what Kim Jong-un himself said as early as the 5th Plenum in December, and has no doubt only gotten worse as a result of the border closures to contain Covid-19. The North Korean economy is facing the most serious headwinds it has seen in the Kim Jong-un era.
Stephan Haggard is a Non-Resident Fellow at the Korea Economic Institute and the Lawrence and Sallye Krause Professor of Korea-Pacific Studies, Director of the Korea-Pacific Program and distinguished professor of political science at the School of Global Policy and Strategy University of California San Diego. The views expressed here are the author’s alone.
Photo from Marcelo Druck’s photostream on flickr Creative Commons.