PIB auction: govt driving a hard bargain

Desperate borrowers, like beggars, can be choosers. But thats conventional thinking - one that has just been shattered in Pakistans banking circles after the government scrapped its PIB auction for the second time this quarter, after growing inflationary concerns drove up yields on the securities.
Apparently, tepid market participation lessened the governments interest in the PIB auction, as it attracted bids worth just Rs15 billion against the target of Rs25 billion. But the essential factor was higher yields.
Investors asked for higher yields on the basis of 50 bps hike in the discount rate to 13 percent, announced in the monetary policy last month.
Even the lowest bids placed were nearly 40 to 50 bps higher than the PIB auction scrapped in the current quarter and 70 to 100 basis points higher from the last PIB auction of the quarter ending June.
As the government wanted to sell it expensive, it rejected all bids in order to reduce the bargaining power of investors. And, according to money market dealers, the governments gentle sales pitch for long-term papers signals that it will continue to reject higher bids in the next PIB auction as well.
It appears the government wants the market forces to move away the yield curve from the market expectation and liquidity preference theory to the market segmentation and preferred habitat theory, as the government is currently portraying that it doesn really need to sell long-term bonds.
Consequently, demand from investors will likely lower yields down the line, since there are a large number of pension fund managers, insurers and other financial institutions, with significant liquidity, willing to invest in the intermediate and long-term bonds.
T-bill auctions, on the other hand, have been witnessing an upbeat momentum as of late.
As investors want to minimize interest rate risk, they are taking long positions in small tenor securities to take advantage of a possible future hike in the discount rate, as growing inflationary concerns are on the horizon.
The last three T-bill auctions have remained unscathed, where the government cumulatively raised Rs343 billion against the target of Rs310 billion, reflecting the governments excessive reliance on treasury papers.
There are two reasons why T-bill auctions hold relatively more importance at this point than PIB auctions. First, the government is longing to raise a total of Rs535 billion from T-bill auctions during the first quarter of FY11 compared to Rs85 billion from PIB during 1HFY11. Second, bids offered on short-tenor bonds are less costly.
This ongoing battle between the government and investors is probably expected to last until the next PIB auction due to be held on October 13. With investors bound to match their asset-liability structure, as evident from the easing of bids in the secondary market, it is quite likely that the government will carry the day when it comes selling PIBs in October.
But thats exactly how far the government can play its cards. Even if yields on long-term maturity bonds are reduced in the next auction, it will be difficult for the market to unrealistically sustain low yields - forcing the government to eventually sell its papers cheap.