The ABC reported yesterday that the Federal Government has issued extra $14 billion in bonds to pay for the ballooning deficit, with more to come as the Budget deficit inexorably grows:
The Federal Government has boosted its issuance of Commonwealth bonds by almost 20 per cent to $86 billion this financial year…
Previously, the AOFM planned to issue $72 billion worth bonds this financial year.
The total of Commonwealth Government Securities (GGS) on issue at June 2016 is now forecast to be $426 billion, up from $412 billion projected in this year’s budget and the $390 billion set down in the 2014 budget.
RBC’s fixed income strategist Michael Turner said the AOFM could keep on track by issuing $1.7 billion worth of bonds every week.
“To put some context around those numbers, for June 2018 expected CGS on issue at that point in time has increased by $83 billion in 18 months,” Mr Turner said.
“This is the equivalent of an additional two years’ worth of net supply at current rates, on top of the issuance that was already forecast to occur.”
However, the flood of new issuance may test the market’s appetite for Australian Government debt.
Readers might recall that in late-2011, the Reserve Bank of Australia (RBA) announced the creation of the Committed Liquidity Facility (CLF), in order to meet the Basel III liquidity reforms. Below is the RBA’s explanation of the CLF [my emphasis]:
The facility, which is required because of the limited amount of government debt in Australia, is designed to ensure that participating authorised deposit-taking institutions (ADIs) have enough access to liquidity to respond to an acute stress scenario, as specified under the liquidity standard…
The CLF will enable participating ADIs to access a pre-specified amount of liquidity by entering into repurchase agreements of eligible securities outside the Reserve Bank’s normal market operations. To secure the Reserve Bank’s commitment, ADIs will be required to pay ongoing fees. The Reserve Bank’s commitment is contingent on the ADI having positive net worth in the opinion of the Bank, having consulted with APRA.
The facility will be at the discretion of the Reserve Bank. To be eligible for the facility, an ADI must first have received approval from APRA to meet part of its liquidity requirements through this facility. The facility can only be used to meet that part of the liquidity requirement agreed with APRA. APRA may also ask ADIs to confirm as much as 12 months in advance the extent to which they will be relying on a commitment from the Bank to meet their LCR requirement.
The Fee
In return for providing commitments under the CLF, the Bank will charge a fee of 15 basis points per annum, based on the size of the commitment. The fee will apply to both drawn and undrawn commitments and must be paid monthly in advance. The fee may be varied by the Bank at its sole discretion, provided it gives three months notice of any change…
Interest Rate
For the CLF, the Bank will purchase securities under repo at an interest rate set 25 basis points above the Board’s target for the cash rate, in line with the current arrangements for the overnight repo facility.
In light of the federal budget deficit ballooning-out to $426 billion by June 2016, and likely to keep on growing, the question for the RBA is: shouldn’t the CLF be unwound and the banks instead required to hold government bonds, as initially required under Basel III? Surely the RBA/APRA should amend the liquidity rules so that Australia’s ADIs must buy government bonds, so that the size of the CLF requirement decreases?
As noted by Deep T way back in 2013:
The cost of the CLF is very low ie 15bps pa, compared to the alternative. The CLF allows ADIs to originate mortgage assets and create RMBS rather than buying government bonds. The net spread on mortgage assets or RMBS compared to government bonds is much greater than 15bps pa probably now in the order of 150bps if you could pull together a direct comparison including costs… This simple comparison demonstrates that the cost to the banks of 15bps is a direct subsidy to all ADIs.
…my advice to the RBA and APRA on the CLF is simple.
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Significantly increase the cost from 15bps pa to better reflect the cost of the alternative of owning government bonds, and
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Due the increase in government bond issuance and the likely sustainability of that issuance, ADIs should be required to hold a significant portion (maybe 50%) of those bonds as part of Basel III liquidity provisions in order to decrease the size of the CLF whilst the bonds are on issue.
Don’t expect any action, though, as it suits the RBA/APRA to keep subsidising the banking sector.
