Rising treasury rates spark costly debt worries - BOJ urged to cut interest rates
Marcella Scarlett, Business Reporter
A marked uptick in treasury rates at yearend spells bad news for the Jamaican Government which will have to pay interest on more than J$420 billion of variable rate debt due for repricing this quarter.
The majority of the upcoming debt payments - which amount to an estimated J$123 billion on overall on fixed and variable rate bonds and other domestic debt - are bundled in February.
For the first time in two years, treasury rates were back above seven per cent and edging towards eight per cent on the three-month bill in December.
Additionally, investors thumbed their nose at two auctions. Usually, T-bills are heavily oversubscribed, but for the last two months of 2012 investors purchased just J$567m of the combined J$800 million of six-month T-bills auctioned by the Bank of Jamaica (BOJ). The lower tenures fared better but had mixed results.
"There is no question that rates have started to go back up," said Charles Ross, managing director of Sterling Asset Management Limited.
Blip or trend?
"The question is, is this the beginning of a trend or is this just a blip?"
Treasury rates which have been rising since the end of summer, closed the year at: 6.31 per cent on the 28-day bill; 7.67 per cent on the three-month bill; and 7.18 per cent on the six-month bill.
Rates were last above seven per cent in January 2011.
Investment advisors, who link the spike to monetary interventions at the time, say the BOJ needs to reduce policy rates to reverse the trajectory on treasuries form the base rate for the pricing and repricing of bond debt - before the February debt servicing bill becomes due.
The higher the treasury yields, the higher the cost of interest payments on GOJ's variable bond payments.
"They cannot sit back and watch the T-bill rate go up. How can they do that when they have a big maturity coming up that will reprice with the next Treasury bill results? They need to cut policy rates now sending a signal to the market so that rates can continue to go down," said Ross.
"Wages and interest are two of the country's biggest expenses and if rates go down when the bonds reprice they would attract lower interest rates and could save the country millions if not billions of dollars in interest payment," he said.
Jamaica will pay interest on J$816 billion of a total J$883 billion of variable rate, fixed, CPI-indexed and USD-denominated bonds by fiscal yearend, March 31, according to the last rate sheet published by the Debt Management Unit of the Ministry of Finance.
Total domestic debt related expenditure to the end of March - including J$89 billion of maturing bonds - is estimated at J$123 billion. Another J$11 billion of interest payments on the external debt is also due in the same period.
The coupons on J$421b of variable rate debt, including the reset margins, ranges from 7.26 per cent to 8.4 per cent, according to estimates last published on December 1. The coupons will be repriced based on upcoming Treasury auction results.
Linked to BOJ auction
Ross, as well as Donovan Perkins, the president and CEO of Sagicor Investments Jamaica Limited, have both linked the spike in rates to liquidity management measures implemented by the Bank of Jamaica in October.
"I suspect that the increase in the T-bill rate is directly related to the BOJ auction in November," said Ross.
"It was a situation of tight liquidity in November and December because the BOJ increased its issues in the prior month, so it is not surprising that T-bill rates increased," he said, referring to three newly devised certificates of deposit issued by the central bank in October.
The CDs had coupons of 6.81 per cent, 7.18 per cent and 7.38 per cent, with the latter rate linked to a 364-day instrument. The rates were more attractive than the existing treasuries, which then had yields ranging from 6.20 per cent to 6.68 per cent.
"The BOJ repos were in direct competition with the T-bill offers for whatever monies was in the system. They are of similar risk so people chose the one with the higher benefit and that was the BOJ issues," said Perkins.
Ross said the performance of the upcoming auctions would offer more insight into whether the upward movement in treasury yields would be sustained, but also noted that rates were unlikely to head south without some kind of intervention.
"We don't see rates going down by themselves either, so there is no reason why people would get into something that won't reprice to get the better yield," said Ross, whose company specialises in bond trading.
"Why would somebody buy a 7.18 per cent T-bill six weeks before the BOJ CD reprices?" he said, referring to the special 364-day CD that will reprice in early February at 100 basis points above the prevailing three-month T-bill rate.
The ministry has not responded to requests for comment on how it plans to finance the interest payments and maturities.
Two of its variable rate bonds will reopen for subscription on January 16 and February 6; two new fixed rate bonds will be issued on February 22 and March 13.
The finance ministry's last effort at fund-raising in December resulted in anaemic take-up of just J$2.19 billion on a reopened variable bond that matures in nine months and is priced to yield 7.755 per cent.
Perkins associates the current tightness in the market to the new central treasury management system introduced in the public sector.
"The central treasury management system can be used to tighten liquidity. If they tighten liquidity too much they will see an upward trend in interest rates," said Perkins, whose group includes a commercial banking subsidiary.
"The central treasury management system takes money out of the system. When money goes to the central bank it is sterilised. It is taken from the system and commercial banks do not have access to it," he said. "Removing this money from the system removes some of the liquidity out of the market. If they manage the system too tightly then interest rates can go back up."
Ross says that how interest rates perform depends on actions taken by policymakers.
"I hope that the trend now is a temporary trend, but everything depends on the policymakers; they are the ones calling the shots," he said.
"I think that interest rates should be going down so that they can roll the debt at a lower rate come February. If they could roll at even 100 or 150 basis points less that would be substantial savings," Ross said.
Perkins said a cut in rates would benefit everyone.
"Right now, the central bank has the perfect opportunity to act," he said.
"The BOJ has significant influence over the direction of interest rates through its 30-day signal rate, which influences T-Bill rates, which sets the pricing for a significant amount of domestic debt, which is variable and tied to the T-Bill auction results. Many central banks for the past three years have interest rates set very low - under one per cent," Perkins said.
A one per cent reduction in rates on the more than J$400 billion of variable rate debt would, he said, "yield more than the significant asset tax levied on financial institutions last year."
The BOJ policy rate, which is linked to its 30-day CD, has remained at 6.25 per cent since September 2011 when it was last reduced. Annual inflation meantime is at 7.4 per cent.