These are not normal times in the global bond market, and Karachi appears to be no different from its larger and more complex counterparts around the world.
The news that the government might flood the market with about Rs300 billion worth of treasury bonds – far from causing prices to drop, as one would normally expect – caused a rally in the prices of government bonds. The reason: the government plans on using that money to resolve that single bugbear of the entire Pakistani economy that has come to be known as circular debt.
“The news reports that the government will soon sort out the conversion of investments and advances (PKR300bn plus) related to power sector circular debt has ignited a rally in PIB [government bond] yields,” said Nurali Barkati, a research analyst at BMA Capital, an investment bank.
The plan being referred to is Petroleum Minister Asim Hussain’s proposal to the cabinet that the government issue bonds that would circulate through the energy sector and ultimately clear out the outstanding liabilities that have thus far financially crippled the energy sector.
The plan is not originally Hussain’s. It was first thought up by then Finance Minister Shaukat Tareen, who issued about Rs90 billion worth of government bonds that were then paid out to power companies, which in turn paid the oil marketing companies who in turn paid the refineries who then paid back what they owed the oil marketing companies. Hussain plans on doing something similar this time around.
There is a simple reason why the bond market likes this idea. Currently, both the energy companies as well as the financial system have hundreds of billions in outstanding loans, many of which are not even actively paying interest.
If the government replaces that debt with treasury bonds, both sides win. The banks get AAA-rated debt that pays interest on time and helps strengthen their balance sheets. The energy companies in turn get rid of their liabilities, which in turn would allow the power companies and the refineries to produce at full capacity.
The economy as a whole would also see some positive effects. Economists estimate that the gross domestic product (the total size of the economy) would grow by 3% faster every year.
That leaves only one question: why should the government do it? Quite simply, because it is their fault. Take the total stock of circular debt: about Rs155 of the Rs300 billion is due to unpaid bills to the power sector by the provincial and federal governments. Another significant chunk of it is due to the unpaid subsidies to the power sector that the government promises but then fails to pay.
The subsidies problem is likely to be significantly reduced or even eliminated this year. The government has been consistently raising prices and trying to improve the efficiency of the electricity grid in order to reduce the amount it needs to pay in subsidies.
In the meantime, the petroleum minister has been forced to take interim measures. For instance, when global oil prices went down last month, rather than passing on the difference to consumers, the Oil and Gas Regulatory Authority decided to let the oil marketing companies increase their margins, with at least part of the difference also going to the government in terms of higher petroleum taxes.
When he was appointed, Asim Hussain was criticised for being unqualified for the job. Yet in recent months, the capital markets have come to respect what appears to be a strong commitment to help solve the energy sector’s most critical problems. A physician by training, he certainly seems to have diagnosed the sector’s problems accurately. Here’s hoping he can deliver the cure.
Published in The Express Tribune, November 14th, 2011.
COMMENTS (8)
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Launch of such bond of Rs 300b will increase not just government debit & its servicing cost but would also impact private borrowing as Banks prefer to lend to government {as they carry sovereign guarantee} which will further deteriorate economy. Also this will be easy way for government to issue New/specific purpose related bonds now & then to overcome its financial mis-management. Just two-year back circular debt issue addressed by then Finance Minister Mr Shaukat Tareen by issuing bond of Rs 90b, which has re-surfaced with increased amount of Rs 300b, clearly evidence that if root-cause of the problem is not addressed this issue will reappear in another year's time. Please get some serious Finance Managers to work on issue with long term solution rather than window-dressing.
This is simply ridiculous. The government had already issued TFC bonds in the past what happened, the government liability in the budget increased. The circular debt grew even bigger. Once again you clear the rot and the government budget for the next 3 to 5 years will be impacted. Will this solve the problem? The answer is no because if you are not treating the disease from inside and external solution will be temporary. The provincial governments are getting transfers from Federal government. Why it can not deduct the outstanding liabilities at source? This is the solution alongwith better financial management at PSEs. In the last episode of TFC, the growth nosedived to 1.7 percent, how can it be improved by 3 percent now?
This is a very good article.
My question: why was this not thought of before?!
I have problems with the estimated benefits on growth. Seems highly exaggerated. So instead of growing at 2.5% per annum the economy will grow by 5.5% per annum? And reduce the power shortage and the economy will grow by 7.5% per annum? Streamline the public sector and reduce their losses and the economy will grow by 9% per annum?
Can't be.
This article has got its facts all wrong. A rally in bond yields means that bond prices have increased because yields have DROPPED (this is because bond prices and yields are inversely related i.e. the lower the price the higher the yield). In money market terminology a yield rally means yields have dropped NOT increased.
Since the end of October the yield on the 12M T bill has increased from 11.78% to 11.85% while the 10 yr PIB has increased from 12.04% to 12.18%. This means that the price of these instruments has decreased (NOT increased as stated by the author of this article).
Whether the bond market likes Asim Hussain's plan or not is besides the point. A significant increase in the size of outstanding debt will increase bond yields and put downward pressure on bond prices as supply increases. And that is exactly what has happened over the last two weeks.
Its surprising that ET can publish business articles without verifying basic facts, terminology and market data.
A logical reason for the increase in price of existing bonds --- The Government will use the new debt to retire the old debt.
Should be done when all policies and measures are in place, to ensure that the circular debt does not balloon up again as has happened this time around.
If we had taken appropriate measures after issuance of 90Bln bonds we would not be facing this problem today of 300Bln circular debt.
I fancy this to be a temporary measure as there are too many compromises an lack of political will shown by this govt to make this a permanent solution.
The way I look at it the Government debt increases adnd so does government debt servicing charges.....ie government will have less to spend on development projects.
Bond market and brokerage houses like the idea because they will make money/commission.
This is a very high-risk policy with a strong likelihood of backfiring in an extremely destructive fashion.