Once again a listless participation was witnessed in Pakistan Investment Bonds (PIBs) auction, as participating amount was lower than the target amount for the third consecutive time. Finally, 3rd PIB auction of this financial year was accepted against the auction target of Rs 20 billion, the accepted amount was Rs 6.385 billion, the offered amount was Rs 17.1 billion.
In 3-years Rs 525 million was accepted at 13.8975 percent yield. In 5-years, the accepted amount was Rs 500 million at a cut-off yield of 13.9991 percent. In 10-years, the accepted amount was Rs 4.468 billion at a cut-off yield of 14.0998 percent, and in 20-years at a cut-off yield of 14.1993 percent the accepted amount was Rs 500 million. Bids in 7-years and 30-years was rejected. The first auction of the current financial year in July was rejected. The second auction that took place in August was also rejected by the Ministry of Finance.
Fixed income securities play an important role and government bond is considered the key driver of developed and developing market. Being the issuer of bond and the regulator, government plays an important role in the development of bond market. Bond market also helps in the formation of long-term benchmark yield curve.
Federal Investment Bond (FIB) was introduced in 1992. Though it was not a very successful experiment, in 1995 another effort was made and corporate sector was provided with an opportunity to launch Term Financing Certificates (TFCs). Finally in 2000, FIBs were replaced by Pakistan Investment Bonds (PIBs).
In Pakistan, so far two serious attempts have been made to develop the debt market without any success. The first attempt was made during the era of Shaukat Aziz from March 2005 to May 2006, when the authorities refused to hold PIB auctions, dampening market sentiment to buy government securities. And recently it was exactly 18-months from now that the then State Bank Governor, Salim Raza, took personal interest and made an effort for the development of government debt market and corporate market, but the follow-up was quite weak, as it required a combined effort of Central Bank and Ministry of Finance to develop a decent bond market.
Recent trouble in countries facing debt problems suggests that in the past countries may have been showing economic growth, but are now facing the music because the growth in such economies was temporary phenomenon, which was made possible through due to stimulus and rescue packages, which is not ever lasting.
Similarly, developing a debt market in present times does not appear to be a suitable proposition from our perspective, at least for the moment. For a successful debt market we need a balanced budget with low spending and high revenue growth. PIBs could be a good hedge against long open positions.
However, rejecting PIB auction was a big mistake, though it is for the fiscal policy makers to decide the fate of auction, but at the same time it is central bank's responsibility to convey to the MOF about the damage and the consequences it would cause to the bond market. Earlier, cut-off would have provided benchmark guidelines to the market and the government would have pocketed cheap money. Refusal to accept previous two bond auctions has surprised the financial market, as the government is struggling for every penny as debt is on a constant rise. Bond auctions do help reduce fiscal deficit.
Had the MOF accepted the earlier two PIB auctions, it might have received Rs 25 billion at an average cost of 13.25 percent, which would have been lower than the current discount is 13.5 percent rate, and yet would have reduce the re-pricing risk. The total amount of PIBs issued during last financial year was Rs 64.7 billion at an average weighted yield of 12.52 percent.
Present Market Treasury bills holding amount with maturities less than 12-months is Rs 1.5 trillion and the weighted cost is 12.40 percent. Total PIB holdings are Rs 500 billion and the average weighted cost is 11 percent. Holding of Ijara Sukook is Rs 43 and the average cost is roughly 12.85 percent. The risky part is that 73 percent of the outstanding stock of government debt carried a duration of less than one year.
There are quite a few factors that do not suit market condition which are also responsible for the failure of developing our bond market. Coupon on 10-year PIB is 12 percent, whereas last cut-off yield of 12-month T/bills was 13.2353 percent. Indonesian bond faced similar situation about a few months ago and they too failed to get market response.
Furthermore, inflation is on a constant rise. There is no scope of liquidity injection in short to medium term in the banking sector and a Rs 1 trillion cash injection is required to square the market. There is no enough space for downward adjustment of fiscal deficit. The growth in bank deposits is based on accrual and there is no new incremental growth, which is a very alarming sign for the financial sector.
Risk of another discount rate hike cannot be ruled out due to a sharp hike in headline inflation. I am looking for a correction with a minimum 2 percent yield gap between a short and long-term curve. Putting money in long term also has a risk that in future in a tighter market condition borrowing against PIB could be a costly affair by 1 percent to 2 percent. Therefore, holding of PIB is a risky proposition and 10- year is likely to surpass 151/2 percent yield in the days to come.