Adam Bornstein and Mehreen Khalid

NexThought Tuesday – Debt is Good: Especially when it helps sustainably fund public health budgets in low-income countries

Out of university, I (Adam) worked for a small merchant bank in Hong Kong as an equity analyst. My boss, Tom, would arrive each morning promptly at 8:25 a.m., plop down into his director’s chair, adjust his glasses, scratch his chin with his Eaton pinky ring, and proclaim, “Good morning, Plonker. Bulls make money, bears make money, and pigs get slaughtered. Find me some pigs!”

And that was about how we started each day for about 18-20 months, until one day Thailand’s currency went into free fall, devaluing massively against the U.S. dollar under the weight of an accelerating Asian financial crisis, driven by mountains of dollar-denominated debt accumulated by these Asian “tigers” to fund infrastructure. Our bank suffered a similar fate and was forced to merge with a Thai financial institution. Good grief, we got slaughtered.

So, it might strike you as odd that after personally observing the negative side of debt that I’m here to tell you that debt, for lack of a better word, is good. Debt can help sustainably fund public health budgets in low-income countries – health expenditures which, in several sub-Saharan African nations, are coming in a bit low as a proportion of GDP.

In a recent Chatham House white paper, the authors recommend that a government should be spending about 5 percent of GDP on domestic public health. In the low-income countries in sub-Saharan Africa, the average level of public health expenditure is only 2.9 percent of GDP. Not surprising, this figure is substantially higher in the European Union and the United States, coming in at 7.8 percent and 8.2 percent of GDP, respectively.

The social benefits of higher public health expenditure, which on average for low-income countries translates into lower morbidity and mortality, are undeniable. The economic returns linked to higher domestic funding for health, and sometimes overlooked by ministers of finance, are no less significant. To wit, a healthy workforce is more productive, leading to better economic performance and higher overall GDP.

With the potential economic uplift associated with spending more on health cemented in binders of research, the question begs: Why are ministers not throttling down on the health expenditure pedal?

The short answer to a complicated question is that governments need to identify and tap new streams of capital. As Tom would say, they need to be bulls.

And, so, within the confines of this endeavor (one certainly worthy of a USAID Grand Challenge), we’ve come up with a solution that allows them to ring the proverbial register, leveraging the mountains of African sovereign debt coming to market over the foreseeable future.

We call it the health bond.

The health bond can either be a piece of sovereign debt or corporate paper issued by a state-owned enterprise – for example, a power plant – whereby the proceeds from the principal investment are used by the issuing entity to fund infrastructure-related projects.

What differentiates the health bond from traditional debt is how the coupon payments are calculated and the proceeds distributed (and redistributed). Whereas in a traditional bond, the investor receives 100 percent of the annual coupon payment(s) plus the principal, in a health bond the investor agrees to sweep, over the duration of the bond, at least 50 percent of the coupon payment into a national health endowment fund.

Once pooled in the health endowment fund – a vehicle which is managed by a clutch of financial, health and independent directors – a majority of the proceeds flow back to the country in the form of health payments to support the country’s national strategic health plan. The balance, to catalyze the endowment process, is invested in low-risk treasuries, which can be done without incurring excessive fees.

Here is the structure of a generic health bond: (1) The Republic of Troy issues U.S. $500 million in 10-year debt paying 12 percent per annum to fund a new hospital and 100-megawatt power plant; (2) Bank International is the underwriter and assigns a U.S. $100 million tranche to diaspora and philanthropic investors, or health bond investors; (3) the health bond investors agree to sweep 6 percent per annum into a health trust fund, which is the equivalent of U.S. $60 million over 10 years; and (4) at the end of the 10 years the Republic of Troy repays all the investors, including the health bond investors, their principal in full.

There are multiple derivatives on how to structure the health bond – for example, layering in guarantees from the World Bank, or setting up matching gifts from foundations and the private sector – which we are exploring. Indeed, because the health bond essentially seeds the country’s health endowment fund, creating a transparent, professionally managed investment entity, there is an unprecedented opportunity to engage the private sector, including both multinationals and domestic enterprises.

As with any financial product there are trade-offs and associated risks. The health bond has its share of weak links in its chainmail as well – one being the sustainability of Africa’s debt market.

Interestingly, a lot of debt has been issued by African governments for infrastructure-related projects over the past couple of years. According to Dealogic, institutional investors have bought nearly U.S. $12 billion in African bonds this year, surpassing last year’s record of U.S. $10 billion. In fact, demand has been so strong that the U.S. $3.25 billion in sovereign debt sold by Senegal, Kenya and Cote d’ivoire over the past two months has been more than five times oversubscribed.

Furthermore, in the face of a hawkish chatter hinting at higher interest rates, PwC estimates that over the next 10 years, African nations will look to raise nearly U.S. $180 billion in infrastructure-related debt.

A second consideration centers around investor appetite. Namely, is there any? (From across the room, seated comfortably in the corner, Tom nods effortlessly in agreement.) So, for sure, we see demand coming from the estimated U.S. $450 billion in global philanthropic-related donations in 2013.

A vast majority of this capital does not get recycled, which is inefficient and a lost opportunity to leverage billions in donor funding. The health bond not only enables investors to fund philanthropic-related programs without “touching” their principal investment, but does so within the confines of a secure, risk-mitigated environment.

Although still early days, we’re working with a select few sub-Saharan African countries to explore how the health bond might play out; the key requirement being, of course, the existence of (or willingness to set up) a health endowment fund.

On this front, we’re actively engaged with a number of ministers in support of these trust funds. Similarly, we’ve also kicked off a handful of discussions with governments and state owned enterprises around upcoming debt placements and the benefit of rolling this debt into a health bond wrapper.

Ultimately, there is significant need to raise additional funding to support public health expenditure. Sure, a bulk of this money will come from traditional tax-based resources, but there are multiple opportunities for ministers to be bulls, make money and infuse much-needed capital into existing national health strategies.

Adam Bornstein is an innovation health financing specialist, and Mehreen Khalid is an analyst focused on innovative health financing, with The Global Fund to Fight AIDS, TB, and Malaria.

Health Care
impact investing, public health