The government’s reliance on the domestic capital markets to fund its widening budget deficits has grown in recent years. The Treasury has sought to lengthen the maturity of its obligations and shift gradually from relying on Treasury Bills (T-Bills) to bonds to reduce refinancing risks. Despite abundant liquidity in the domestic financial system, commercial banks claim they are increasingly broaching their single-borrower sovereign exposure limits. Although the introduction of a real-time gross settlement system (RTGS) for high-value transactions may support the growth of the Bank of Papua New Guinea’s (BPNG) repo market, authorities also plan to launch a secondary market for government paper in the coming years.
Tapping Domestic Markets
Surging commodity-linked export revenues allowed PNG’s government to reduce the their debt-to-GDP ratio from 39.5% in 2006 to 22% in 2011, according to Standard & Poor’s (S&P). However, the value of aggregate debt rebounded sharply in the two years to June 2013 to reach 31% of GDP, according to the World Bank. Yet while foreign-currency debt grew modestly from 7.9% of GDP in 2012 to 8.1% in 2013, mostly driven by the impact of the depreciating kina on aggregate external debt levels, the state relied mostly on domestic deficit funding, which rose from 18.7% to 24.6% of GDP in the same period.
International development partners hold the entire stock of external debt, according to BPNG. Meanwhile, some 47% of domestic outstanding debt in June 2013 was in the form of T-Bills, with average maturities of six months, according to the World Bank, while the average tenor of aggregate debt was four years. Over the course of 2013, the prerogative for new debt issuance was transferred to Parliament.
The central bank has consistently advised government to tap domestic funding sources to finance its deficit, both to mop up excess domestic liquidity and reduce upward inflationary pressure potentially caused by new external borrowing. The 2014 budget plans to rebalance borrowing towards inscribed stock to lengthen the average maturity profile, while the total stock of domestic debt is budgeted to increase from PGK8.75bn ($3.56bn) in 2013 to PGK10.46bn ($4.25bn) in 2014. The Treasury expects to float some PGK5.1bn ($2.07bn) in new T-Bills in 2014 to cover repayments of PGK4.96bn ($2.01bn), reducing the share of T-Bills from nearly 47% of domestic debt to 40.6%, and plans to expand the value of outstanding bonds from PGK4.64bn ($1.89bn) to PGK6.21bn ($2.52bn).
While this will reduce mid-year refinancing risks, it will also bring a higher associated cost. Interest rates on six-month T-Bills has trended downwards from 3.87% in 2011 to 2.52% in 2013, while yields on 10-year government bonds fell from 10.34% to 9.16% in the same span, according to Kina Funds Management.
In the absence of a liquid secondary market for bonds, corporate issues have essentially been private placements, with bondholders buying such securities to hold until maturity. “At the moment PNG is characterised by a buy-and-hold mentality, where investors hold onto their bonds until maturity,” Richard Borysiewicz, BSP Capital’s general manager, told OBG. New private issues may become available in 2014, with the International Finance Corporation planning a kina-denominated bond issue to raise PGK200m-300m ($81.3m-121.9m) in 2014. The first supranational bond issue on the PNG market, rated triple-A and thus likely to fetch lower yields than government debt, the IFC issue would be significant in further developing the domestic yield curve and could attract issuance from other agencies, such as the Asian Development Bank (ADB), to finance part of their kina lending.
Investor Base
Government debt is held predominantly by commercial banks and, to a lesser extent, superannuation funds, life insurers and a handful of non-financial corporates. By March 2013, retail banks held 70% of total outstanding government debt (T-Bills and bonds combined), or PGK5.02bn ($2.04bn), while other financial firms, such as superannuation funds and insurers, held another 20%, or PGK1.31bn ($531.7m), according to BPNG figures. Commercial lenders have long been the main purchasers of T-Bills, while the market for inscribed stocks has drawn a wider array of investors eager for longer-tenor, risk-free securities. Foreign appetite for local-currency bonds has been constrained by the high 15% withholding tax on interest revenues in PNG. Meanwhile, the outlook for banks’ appetite for new T-Bills is constrained by their current holdings. “While Australian banks may be close to their single borrower limits, Bank of the South Pacific is likely to still have some appetite for local bond issues,” said Craig Michaels, S&P’s sovereign credit analyst for PNG. The government has conceded this fact. “There has been sufficient liquidity internally to finance the debt so far, but we are reaching the outer limits of this, especially because we will continue a deficit budget in 2014,” said Charles Abel, the minister of national planning.
In 2013 the Treasury and BPNG reduced the barriers to investment for retail actors, cutting the minimum investment for T-Bills from PGK100,000 ($40,650) to PGK10,000 ($4065). Yet non-financial resident investors’ share of the domestic debt mix has remained low, decreasing 0.1% in March 2011 to 0.064% in March 2013, according to BPNG. As banks have withdrawn from new government securities issues, superannuation funds have become the main purchasers, buying the majority of issues in the first quarter of 2014. “Superannuation funds have been able to purchase government bonds at good prices as a number of other market participants, like overseas banks, already have high exposure to PNG sovereign debt and are approaching their credit limits,” Michael Block, chief investment officer at superannuation fund Nambawan Super, told OBG.
Bond Trading
The level of over-the-counter trading between bondholders remains marginal in PNG, with few instances such as PNG Sustainable Development Programme’s sale of their government bonds to Nambawan Super in early 2014. Launching secondary trading in government bonds would likely stimulate higher demand and bring downward pressure on yields. “Creating a liquid secondary market for inscribed stock would facilitate this transition,” Tim Bulman, the World Bank’s country economist for PNG, noted in a December 2013 update. “Giving investors greater scope to trade inscribed stock after they have been purchased would reduce the yields they demand.” Such a market will also have a positive impact on PNG’s international credit rating, according to ADB, by deepening capital markets and providing more flexibility in managing domestic liquidity. Indeed, local institutional investors face the challenge of there being few liquid investment instruments, with liquid deposit accounts yielding below-inflation returns and high-yielding bonds largely illiquid. “The cost of liquidity in PNG is very high: the return on short-term liquid deposits is around 1%, compared to over 12% on long-dated bonds, so the opportunity-cost of liquidity is very significant,” said Block.
Exploring Options
While BPNG floated the idea of secondary bond trading as early as 2010, authorities are considering a number of potential means to jumpstart the market. The formal launch of RTGS for high-value payments in 2013 was an important step in formalising the BPNG-run repurchase market for government securities, although given abundant liquidity in the banking sector, this had not been used by the first quarter of 2014. The Port Moresby Stock Exchange has proposed that the government sell at least some bonds through its platform. The upgrade to the electronic settlement system completed in 2012 has also allowed for shorter latency times.
One option would be to leverage off of Bloomberg terminals in use locally, as a ready-made secondary trading platform. “The quickest way to introduce secondary bond trading would be to register governmentinscribed stock, give them an international securities identification number and start trading them openly on Bloomberg,” Eric Kramer, the CEO of PacWealth Capital, told OBG. “There is currently nothing PNG-related on Bloomberg, but introducing electronic settlement and the creation of a repo market would change this and provide much needed liquidity. All stakeholders will be served by these developments, and it will ultimately help attract foreign portfolio investment.” Only the Kina Group and BPNG have Bloomberg terminals in use, while BSP Capital will acquire one in 2014.
Despite repeated delays, it is likely that the impetus will increasingly come from bondholders, as banks near their sovereign exposure limits and as the tenor of outstanding government securities lengthens in coming years. Although PNG has entertained a number of potential foreign-currency funding sources, other than concessional funding from development partners, the state continued to rely overwhelmingly on domestic sources in its 2014 budget. While the government’s medium-term debt strategy includes provisions for the launch of a secondary market, authorities will need to clearly articulate the model they intend to follow. This will be key to reducing yields on public debt and developing more savings instruments for retailers. Revising the tax code to reduce withholding tax barriers would also be key in attracting foreign portfolio investment.
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