Imprudent strategy: Debt structure changes at a time of falling interest rate

Govt switches from short to long-term debt, which is proving expensive.

ISLAMABAD:

In the last one and a half years, the domestic debt structure has undergone significant changes as the government is now banking on long-term debt-creating instruments – a strategy which experts say does not make sense at a time when the discount rate is expected to fall further.

The share of short-term debt in total domestic liabilities, which was 54.5% in June last year, went down to 40.4% by the end of October 2014. In absolute terms, the floating debt was Rs5.2 trillion and dropped to Rs4.5 trillion, down Rs664 billion or 12% in just 14 months.

When the PML-N government came to power in June last year, it immediately faced the challenge of debt rollover and refinancing. At that time, the strategy to change the domestic debt mix was worth considering aimed at easing the burden on commercial banks for deficit financing.

However, rapid economic developments at home and abroad over the last six months necessitate a change in the strategy. But it seems that the Ministry of Finance is oblivious of the developments and lacks the ability to make forecasts for the short to medium term. In the absence of such projections, the burden is mounting on the public purse.

The government is replacing short-term papers of up to one year with medium to long-term Pakistan Investment Bonds (PIBs).

In June last year, the outstanding PIB stock with maturities of three to ten years was just Rs1.32 trillion or 13.9% of the total domestic debt of Rs9.5 trillion.

However, by the end of October this year, a whopping Rs2.2 trillion was added to the PIBs of such maturities, taking their total stock to Rs3.5 trillion or 31.3% of domestic debt. Overall, the domestic debt rose to Rs11.2 trillion.

When that happened, the Ministry of Finance’s Debt Management Office was virtually dysfunctional in the absence of its head.

However, the change in the debt structure has come at a price. In the last fiscal year alone, the country paid an additional Rs54 billion for the shift from short to long-term debt, as the PIBs on average gave 2.5% higher return compared to treasury bills.

Debt servicing and repayment of foreign loans was the single largest expenditure in the budget in July-October of the current fiscal year. The country spent Rs557.4 billion or 48% of total expenditures on debt-related obligations in the four-month period.

Of the total, Rs434.4 billion or 36% went to servicing domestic debt, Rs38.1 billion to servicing foreign debt and another Rs85 billion to foreign loan repayments.

Because of the change in the debt repayment period, the cost of debt servicing as a percentage of export earnings rose to 27.6% by the end of first year of the PML-N government, which was also the end of fiscal year 2013-14. The ratio stood at 26.2% in the last year of the Pakistan Peoples Party government.

Discount rate

Macroeconomic indicators suggest that investment is not rising and inflation has dropped to 3.96%, the lowest in 11 years. On the back of a steep decline in the Consumer Price Index, the State Bank of Pakistan (SBP) has cut its key policy rate by 50 basis points to 9.5%.

This will bring down the government’s debt servicing cost by roughly Rs55 billion on the domestic stock of Rs11.2 trillion.

Economists see a further reduction of 100 to 150 basis points in the policy rate. The central bank will be under immense pressure to cut the rate in the next monetary policy, though the Monetary and Fiscal Policies Coordination Board and the International Monetary Fund are advocating a cautious approach.



The conditions suggest that the Ministry of Finance should not go on a borrowing spree. But the situation is contrary to this. In the last auction of PIBs for three, five and 10-year maturities held on November 19, the Ministry of Finance raised Rs150 billion.

It borrowed Rs72.2 billion at a cut-off yield of 10.898% for three years, Rs27.7 billion at 11.1% for five years and Rs50.4 billion at 11.99% for 10 years.

Experts see no rationale behind long-term borrowing and suspect that certain quarters are benefiting from this. There is a need to hold an impartial inquiry.

Debt at higher prices

According to a research paper recently presented by Syed Salim Raza, former SBP governor, debt markets have accommodated government’s debt only at higher rates while private lending was squeezed. From 2007 to 2014, investment by banks in government securities increased four times while private sector credit was squeezed.

According to the paper, banks hold 97% of the PIBs, thus setting the price for all other government debt.

For developing efficient debt markets, an empowered and independent debt management office is indispensible at the Ministry of Finance, suggests the former central banker.

He says the debt office’s primary mandate should be to reduce cost, develop debt sustainability and contribute to building the framework for broad-based debt capital markets.

The government has now hired Ihtisham, a treasurer, to run the debt office. How independent he will be or shots will still be called by the Q-block, only time will tell.

THE WRITER IS A STAFF CORRESPONDENT

Published in The Express Tribune, December 15^th,  2014.

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