The deadlock between the fiscal and the monetary authorities over issuance of long-term government paper finally ended with auction announcement for Pakistan Investment Bonds, to be held at the end of the month. However, disagreement on the issuance amount, for the current financial year, as well as on pricing still persists, it is reliably learnt.
While the mandarins in finance are concerned in trying to keep a lid on the interest cost of the budget - the banking authorities want Islamabad to stop being myopic and instead take a long-term view to develop the capital market for larger good of the economy.
For the last two years, the State Bank of Pakistan (SBP) has been asking the government to hold PIB auctions with regularity in order to develop secondary market for long-term Bonds. When interest rates were falling, the government chose to issue short-term Treasury Bills to take advantage and reduce the interest cost of the budget for the year. Even outflows from the NSS, which are of long-term, were retired through short-term borrowing, thereby, tilting the government debt profile towards short-term.
After a lot of persuasion from the central bank, the government held an auction of a meagre amount of Rs 10 billion on May 19, 2006 - when the budget year was due to end. In order to keep the interest structure unchanged - the whole amount was picked after cajoling government-managed organisations such as Slic, EOBI, KPT and OGDC to pick the total bond issue.
Banks were thus denied from obtaining any bond issued on May 19, 2006. As a result there is no trading of this particular issue on the secondary market.
Since July this year, the SBP has been pressing Islamabad to issue long-term paper with regularity. After a lot of persuasion - permission to hold an auction in the amount of Rs 15 billion was given. Monetary authorities felt this amount was too small and wanted a clear direction for issuance of PIBs during the current fiscal year through a jumbo issue announcement. Islamabad reportedly responded with a figure of Rs 40 billion. The SBP wanted it enhanced to Rs 85 billion in order to reduce the bank borrowing in the budget and shift it to non-banks to ease inflationary pressure, but the deadlock persisted.
In response, the Finance Ministry sprung a surprise on everyone by allowing corporate to once again enter into National Saving Schemes in order to shift the budgetary bank borrowing towards non-banks.
Once again the to and fro communications continued with monetary authorities wanting the PIB coupons to be revised and reflect the pricing of these bonds on the secondary market.
Finance reportedly has relented to consider enhancing the amount to Rs 60 billion, but only after seeing the market response in the end October auction. However, the Finance Ministry refused to change the coupon rate as it would give a very strong signal of a change in interest rates.
SBP''''s announcement issued last Saturday, maintains the same coupon rate for three-, five- and 10-year PIBs maintaining the amount at Rs 15 billion. However, three-, five- and 10-year issues will not be fresh issues, but a reopening of May 19, 2006 issues. This in effect means that buyers can encash the first coupon within a month of their purchase instead of waiting for six months.
Usually, past issues are re-opened, in a later auction, if market is short of tradeable bonds of that particular issue. Re-opening a past issue helps institutions, which are short to cover themselves in the auction. Their hunger makes them bid at finer pricing this helps the seller (ie government).
Repo activity on the secondary market of a particular issue is indicative of the market being short. At present, repo activity shows that same banks are short in April 29, 2005 PIB issues. No bank is, however, sitting short on May 19, 2006 issues - in fact, they have none and, therefore, there is no activity in the secondary market. The danger in reopening past issues is that the amount of maturity bunches up at the maturity date. Therefore, cash flow implications for the budget has to be considered for re-opening a past issue.
Since the quantum of May 19, 2006 issue was only Rs 10 billion, the SBP apparently feels it is safe to add another Rs 11 billion and get a liquid yield curve for the issue. This can only happen if banks buy the bonds. In case non-banks are active once again the strategy will fail.
A cursory glance at the secondary market shows that the coupons for 15 and 20 years PIB (enhanced by 50 and 100 basis points for the forthcoming auction) do reflect the trading price on secondary market. However, for three, five and 10-year PIBs the coupons are not aligned with market yield. Therefore, market watchers expect bids at heavy discount for at least the 10 years PIB for buyers to get an effective yield.
According to economists, the opposing views on interest rates and their impact on growth targets are quite common between fiscal and monetary authorities the world over. However, these contentious issues come into play in short-term instruments like T-bills which is one of the tools in the bag for conducting open market operations by a central bank.
Long-term paper pricing are not an indicator of present inflationary trend, but more of a reflection of markets view on future growth prospects of a country''''s economy.
Secondly, issuance of long-term bonds by the government creates a benchmark for long-term borrowings to fund industrialisation as well for financing infrastructure projects as it enables corporates to float their own paper in the capital market and helps banks to maintain their loan to deposit profile properly aligned.
Governments burdened with high debt continue to hog household savings as well as bank deposits. Despite lowering of debt-servicing cost and a downward trend, the non-issuance of PIBs with regularity by the government shows the country is not out of the woods and still has long way to go to lower the debt burden to a sustainable level, the economist added.
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