The PIB auction is scheduled today. Recent behavior of auctions is erratic. With DG debt at the helm, Ministry of finance has to give the right signaling. In December 2018, the government fetched a small amount at 13.15 percent in 10Y PIB - the policy rate was 10 percent back then. This space warned ministry to not repeat 2014 mistake, but it did. There was no acceptance in the Jan19 auction, and in Feb19, the rate came down to 12.85 percent, before heading back to 13.15 percent in Mar19.
Had the government not accepted any amount in Feb19, there would have been a chance for rates to come further down. It is not too late, there is still time to mend the mistakes. The interest rates are close to peak and short term rates are high, but long term inflation outlook is lower than current number, the long term rates should be on the lower side.
The slope of the yield curve has to be flattish, if not an inverted yield curve, as was the case in many instances during 2009. Since the policy rate has revised up after the last auction, and based on mixed signaling in the previous auctions, the market may even bid at higher rates for targeted Rs100 billion in fixed PIBs. If that is the case, the government should reject it
The need is to signal the market that the rates are expected to come down in a few quarters, and next time the market may offer a relatively low rate. And even if that rate is deemed not fit, reject it again in May, and let the market come down further. Do this, till the market adjusts to ground realities. Meanwhile, if anything is offered at lower rates, accept it. Nowhere in the world is the yield curve steep, in a peaking interest rates scenario. The yield of Pakistan foreign currency bond came down by around 200 bps to 7 percent, how can we offer fixed rate of 13 percent plus in domestic paper.
However, the minster might be eager to improve the maturity profile of the domestic debt as the general perception is that there is high roll over risk due to skewed investment in short term papers. That is not the right interpretation - maturity profile is more of a concern in external debt rather than in domestic debt. And the rollover re-pricing risk is an issue in days when interest rates are at bottom. Today, the rates are nearing peak, and the argument of rollover risk is misplaced.
The government may still want to build a long term yield curve and improve maturity under the soft condition of the IMF. In that case, opt for floating PIBs. Banks dislike the floating instrument at the peak rates as it is time to have windfall gains by buying fixed PIBs at discount. It happened in 2014 and the banks would love a repeat in 2019. But government should learn by not letting banks to make easy bucks, at the cost of taxpayers’ money.
The floater is a new instrument and neither banks nor Mo0F are clear on the spread. In previous auctions, government did not give higher spread than 70 bps over 6M T-bills. Last PIB auction was at 13.15 percent while 6M T-Bill was 11.09 percent. There is a huge gap between the two and government can comfortably increase its spread over 70 bps. The problem with higher spread is a scenario of interest rates moving up significantly, but that is unlikely. In days of low policy rates, higher spread on floaters may not be a good option, but today, it makes sense to lure the market in floaters.
The market appetite can be gauged from the fact that recently, a Sukuk of Rs200 billion was issued at KIBOR plus 80 bps which is around 6M T-Bill plus 100 bps. Hence, market may be keen to fetch floater bond close to 100 bps spread. But the MoF may not want to set a precedent of higher spread on floater. In that case, simply scrap anything over 70 -80 bps. But not at the cost of high rate fixed PIBs.
Bottomline - say no to fixed PIBs at any rate higher than 12 percent and if there is a compulsion of positioning in long tenure bond, go for floaters, if higher spread has to be given.
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