The Czech Republic’s “Republika“ Bonds: "Don't hesitate and get it done in time." Says Mrs Minister.


A Christmas Present from Scrooge?

You can't make much money on government bonds. They are a typical illustration of the widely accepted "risk - return" concept. The idea that "the state will surely give you your money back with a little bit extra" indicates that investors will not lose much money in real terms - just some of it.

In the Name of the Republic

The Republika bonds, issued by the Czech Ministry of Finance in consecutive tranches, is no exception. Two types of bonds were prepared for the period up to 31 December 2020: reinvestment bonds and anti-inflation bonds. The Czech Republic has been offering them since 2019 appealing to the public's patriotism, because "It has been more than 100 years since the founding fathers contributed to the establishment of independent Czechoslovakia and thus began a new era of Czech and Slovak history." It is worth noting that some bonds issued in connection with Czechoslovakia's foundation almost a hundred years ago (bonds issued in 1922, denominated in US dollars) have not yet been repaid to foreign investors as a result of the vicissitudes both with the communist regime, and with the post-communist bureaucracy.

I'll take the socks please, or maybe a new bike

We can tolerate a small inaccuracy: both types are in principle reinvestment bonds. However, the advertisement for the general public, made in the pre-Christmas atmosphere by the Minister of Finance Alena Schillerová - and thus the Ministry of Finance is rather remarkable: Bonds with a paper certificate as a Christmas present.

In her contribution on social networks, the Minister promoted a profitable investment in bonds indirectly as an alternative to - in her opinion, the traditional - Christmas gift: socks. Reinvestment bonds are said to provide higher returns, even with interest rates rising over time, while conservative anti-inflation bonds bear interest equal to the calculated inflation rate (based on CPI) plus a premium of half a percent above. And the best time for investment is right now (Alena Schillerová, 8 December 2020): "So don't hesitate and get it done in time."

The rationale behind the anti-inflationary bonds is obvious, however, let's look at the returns of both types of the Republika bonds in real terms.

For the value of CZK 1,000 (the amount of the minimum investment), you can buy roughly 20 pairs of quality socks today, but that seems a bit too much for Christmas. Let's give another example: A fifteen-year-old son longs for a new carbon-frame bike, because with the old one he simply can't impress anyone and can't catch up with his friends. And for Christmas, he receives the Republika bonds with an explanation: "The old bike will last another six years, and then (for the "bond money") you will buy a new one even with pedals!" And that pays off! For non-cyclists: better quality bikes are sold without pedals, or with pedal imitations that can hardly be used for riding.

On the other hand, a multimillionaire who doesn't know what to do with his money may ask: should I let my millions lag behind inflation in a ridiculously low interest-bearing bank account or should I try to preserve the value by investing in anti-inflationary bonds? After all, I don't need the money for anything now. By the way, this is a question that the author of the article has encountered, and is entirely justified.

Misleading Promotion

Looking closer at how the anti-inflationary bonds have been promoted on the Ministry of Finance's webpages: The attractiveness of investing in bonds is illustrated by reference to a total yield calculator.

The interested party is encouraged to enter his or her assumptions on inflation rates over the next five years, for example, 2% per year - i.e. in the amount of the CNB's inflation target. By the way, the 2% inflation rate has been considered economically sound in many countries since 1992, when the US Fed called it reasonable in line with its monetary and economic goals (maintaining adequate economic productivity and a reasonable level of unemployment).

With 2% inflation and a guaranteed premium of 0.5% above CPI, the investor will get after six years a nice nominal amount of CZK 1,161.33 from every thousand crowns invested in 2020 (or early 2021). According to the amendment to Act No. 586/1992 Coll., on income taxes (the so-called tax package), yields on government bonds issued after the effective date of the law will even be exempt from income tax (i.e. from 1 January 2021) - nevertheless beware of the bonds issued before the end of 2020.

Inflation will go on, and in the example above, the koruna in 2026 will be worth about 90% of the koruna's value in 2020. So, according to the CPI calculation, you buy a "consumer basket" for some CZK 1,030 (in real terms) - i.e. for the same koruna six years later. However, this would be the case if your housing costs continued to account for about a quarter of your spending, food, beverages (including alcoholic beverages) and tobacco for more than a quarter, while education just 0.6%.

With the less conservative (as Mrs Minister says, i.e. riskier) reinvestment bond, you will end up even worse. The amount will bear interest at a dizzyingly rate rising from 0.5% per year (in year 1) to 1.5% in the last year of reinvestment, and the amount received at maturity will be CZK 1,063.72 - after six years. With this money one can buy the same goods and services as today for CZK 943, i.e. less socks than what we can buy today for a (non-invested) thousand. In other words, over 6 years you've turned your CZK 1,000 of purchasing power into just CZK 943. Hardly a great investment!

In 2019 and 2020, bonds totalling CZK 25.5 billion were subscribed for. In the recent ninth round so far - the Christmas round on 31 December 2020 - the contribution to the state coffers was CZK 5 billion. The Minister's advertisement has undoubtedly borne some fruit. However, the rhetoric and - for laymen - misleading calculation on the Ministry's website cannot be considered fair: after all, if one enters high expected inflation rates into the presented calculation table, the resulting nominal amount will be marvellous - i.e. hooray towards the highest possible inflation! In real terms, however, it will still be the 0.5% in the case of anti-inflationary bonds, and a complete disaster for the reinvestment bonds (maybe deflation would help, but you can't rely on it).

Note the recent remarks of one of our truly renowned economists, former Governor of the Czech National Bank, Miroslav Singer, made on 29th December, 2020 in relation to the level of savings of the population, which may have led to a relatively high purchases of the Republika bonds in the last round so far: "... there is a lot of money in the banks that can 'easily live' with even extremely low returns". But also his prediction that "inflation is likely to return to two percent, unless there is a catastrophic harvest-destroying weather development."

Here's Your Present, Please Don't Cry

Subscription to the tenth round of the Republika bonds will run until 1st April, 2021. The parameters may still change, however, a normal small investor should consider the implications of his or her deferred consumption to the maturity date of the bonds from the real-yield (inflation adjusted) point of view rather than just the nominal-yield perspective promoted on the Ministry of Finance's website. Potential investors should also consider the 'opportunity cost' in terms of the benefits of purchasing now, or alternative investments, versus a guaranteed value sometime in the future. After all, a fifteen-year-old boy who gets a good bicycle for Christmas will make a bigger impression today than with the same model in six years time. Oh, and don't forget to add a little more money to buy the good pedals.

PhDr. Michal Mareš, MBA, CFA