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Pakistani Bond Market Outlook

April 27, 2017

@asadcmka
by Asad Rizvi

Yesterday’s T/bills auction result provides further guidance that the government is worried about the extra cost it has been paying for years due to accumulation of debt largely caused by higher Discount/Policy Rate that has badly hurt growth. I think what should more worrying factor is the repayment plan, which is pushing stocks higher.

Fiscal managers may argue/think that until external debt reaches threshold level of 50 pct of the GDP, which is currently around 26 pct there is nothing much to worry about, as this level will not be reached in next 10-years. But with the ongoing economic trend the economy cannot afford reckless and smug approach, as borrowing for repayment purpose will remain a daunting task as size and cost will rise at a faster pace.

Fiscal Managers should take a leaf from the theoretical problem they face due to high level of Domestic Borrowings, which is not utilized for productive purpose such as infrastructure development or structural reforms, instead borrowing is done to pay interest and rollover of maturities.

Though government may claim to have avoided monetization, but they had to pay extraordinarily high interest rate payment to the bond holders through backdoor (OMO) to manage deficit and meet to IMF numbers.

However, the pressure is likely to mount as cash flow crunch (Domestic & External) will continue to haunt the authorities because of low Tax to GDP rate, falling export trend and high import (raw material purchase) and unnecessary import of luxury items. Increase in energy production should boost the economy or else it will add to the pain, as size of circular debt will further inflate that may become more worrisome factor.

As we are Debt Based Economy, ongoing economic condition since several years have lead to decrease in money supply due to cash squeeze in the banking system. To fill the gap State Bank of Pakistan is constantly playing role by using its monetary tool by providing assistance to this Fiscal related problem in providing funding through its regular fortnightly OMO’s and RS/USD SWAPS.

In coming Budget, I do not see major policy shift in its Fiscal stance that may give boost to increase money supply that may help to ease tighter liquidity condition. In such a situation debt burden is more likely to increase, resulting rise in foreign and domestic borrowings to manage the cost.

Unfortunately the economy for quite sometime is clogged due to,”Crowding Out” factor, which means government is borrowing against sale of bond. Hence Private Sector gets less money to spend, as less riskier bond is made more attractive by offering higher return. This is why since June 2013 GOP Securities have surged from Rs 4.721 Trillion to Rs 8.62 Trillion.

In his February 2017, Finance Minister Isaq Dar in his press note mentioned about shift in his strategy in managing Refinancing Risk of Domestic Debt by pointing that the Average life Time to Maturity of Domestic Debt has increased to 2.1 years from 1.8 years.

This is why government had to pay high price due to higher Discount/Policy Rate, as increase amount in GOP Securities was from July 2103 till date is Rs 3.082 Trillion.

Now as the nation is approaching Election year and the Financing of debt remains major cause of worry. I do not see any reason for hike in interest rate. Inflation is likely to stabilize around 5 pct as oil prices is unlikely to average above $ 55-60 and may dip below $ 50 because of 5 % ARAMCO sale. Oil glut is is another worrying factors.

Therefore, in all probability I do not see any reason for government to succumb to market demand to accept bonds at higher yield. As witnessed in 1st PIB auction of Q4, demand for higher yield was outright rejected. Since July 2017 against T/bills target of Rs 5.85 Trillion accepted amount is Rs 6.084 Trillion and against PIB target of Rs 700 Billion, amount of bond is in excess by Rs 98 Billion.

From here onward, I am expecting mild shift in auction strategy, as government will most likely refuse to offer higher return on bonds and may be willing to make minor adjustments in T/bills Rates, which suits them cost wise.

Therefore, while formulating strategy what Bank’s Treasury has to keep in mind is the overall size of GOP which is currently Rs 8.620 Trillion, hence, they cannot afford missing any auction, whereas as Central Bank has the liberty to offer cut off of their desire level.

In all probability, government bond until 10-years is still best bet, as I do not rule out cut in Policy Rate and Coupon Rate, which will arrest sharp rise of Domestic Debt and ease tax payer’s burden to some extent.

(Disclaimer applies in my post, which means that the perspective is my personal view. I have made every effort to ensure accuracy of information provided. However, accuracy cannot be guaranteed. This article is strictly for information and not intended for Trade or Business Transaction). 

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