Like the equity markets, the debt markets in Papua New Guinea are set for a major overhaul. Work is being contemplated and being done, with World Bank support, on the relevant market infrastructure, regulators and regulations, and the processes and procedures for the issuing and trading of securities. The debt markets at the moment are largely over the counter (OTC) and manual, with a low level of transparency. If all goes according to plan, in a few years bonds will be trading electronically, local banks will be acting as market makers, ownership will be diversified and foreign investors will be regularly buying local bonds and trading actively in the secondary market.
Weak Foundation
The legislative underpinnings of the market are outdated and relatively weak. These include the T-Bills Act 1974, the Loans (Overseas Borrowing) Act 1973, the Loans (Overseas Borrowing) Act 1976 and the Loans Securities Regulation 1960. While these are sound documents, they are not necessarily in line with modern debt management practices. Regulatory authority for bonds is not clearly defined, with the Securities Act 1997 excluding government securities. The Bank of PNG takes the role of a regulator, with the particulars of government bond activities, including bidding procedures, repayment details, fees, transfer details and tender results, covered in a memorandum of understanding.
The timing of debt auctions, and notifications of them, have been challenging for investors. Bidders have said that confusing signals regarding the schedule, and the cancellation of some auctions, have led to uncertainty and may in part be responsible for the lack of subscriptions at times. The amount of Treasury bills (T-Bills) being sold are often not known until the day of the auction. Information flow and transparency also remain poor. The annual borrowing plan, which is supposed to be published by the financial management division of the Department of Treasury, was not issued publicly in 2015, while the quarterly government inscribed stock (GIS) plan was last published in 2013. The last T-bill update was in 2013.
The market is neither diverse nor very liquid. There is only one corporate bond issue, from BSP, which trades on the POMSoX. All the rest is government or central bank debt, and almost all of it purchased in the primary market. The GIS currently runs from three to 17 years in duration, and T-Bills run from 182 to 364 days. The Bank of PNG sells Central Bank Bills, which are from 28 to 182 days in duration. The interbank market is highly illiquid and only has activity overnight, while the central bank makes no standing facility available to the commercial banks.
In Need Of Reform
The primary market for government securities is highly manual. Registered bidders place their orders via email while non-registered bidders make orders accompanied by cheques. The World Bank, in a draft copy of a 2015 technical assistance report published by the central bank, sees this process as discouraging to foreign investors. Almost no trading occurs in the secondary market. Most major institutions in the country practice a buy-and-hold strategy. The secondary market, when it exists, is phone-based and OTC. Some institutions are wary of buying longer-dated securities due to the lack of a secondary market, as they may be in need of cash at some point and unable to raise it by selling their longer-dated paper. As a result, activity tends to be concentrated in the shorter-duration bonds.
Ownership remains highly concentrated. Superannuation funds and the banks hold 70% of the domestic debt, while the central bank has 22% of the outstanding debt. According to the World Bank, the lack of more diverse participation in the debt auctions could result in a situation whereby the government is a price-taker, and the competitive auctions generate less than optimal results. While the government debt market allows for the government to raise funds, in recent years it has faced periods of stress. Interest rates on government securities have risen, and at times issues have been undersubscribed. The government’s debt programme has not resulted in a good range of securities in the market. Issues outstanding tend to be at durations of under 12 months, which is not seen as ideal as it can result in fiscal difficulties during periods of heavy refinancing.
In The Works
Some progress has been made in improving the functioning of the market. In terms of Central Bank Bills, the bank of PNG offers the Central Bank Bill Tap facility. This programme allows small investors to buy the bills on offer via the central bank on a non-competitive basis. Take up, however, has been low. Discussions have been under way to introduce the Bloomberg Automated Auction System for the trading of government securities and central bank bills. The terminal allows registered bidders to submit their bids directly to the fiscal agent, which is seen greatly reducing operational risks. In terms of legal underpinnings, the central bank has drafted a master repurchase agreement, and all but one of the banks had consented to the draft by the end of 2015.
PNG has been discussing the issue of a sovereign bond, demand for which is seen as potentially strong. The country’s public debt is not particularly high, and it has room to add more if necessary. According to IMF calculations, the total fell from 62% of GDP in 2004 to a manageable 22% in 2011. It has since returned to levels above 40% but is still seen as low. External debt fell from above 50% in 2011 to around 16% in 2014. Public sector debt is expected to remain stable and decline ultimately to about 35% of GDP by 2035, according to IMF calculations.
Local institutions have received enquiries from foreign investors saying that they would like to get involved in the local debt market. While foreign purchases could be good for the country in terms of expanding the investor base, concerns remain about whether the market infrastructure is up to the task. The entrance of foreign investors will also require careful monitoring, as flows of funds from overseas can be disruptive during times of volatility.
Recommendations
In its technical assistance document, the World Bank recommended that the laws be amended to take into account changes in the market and the country’s objectives. The bank also suggested a code of conduct be developed to cover investors buying government securities and central bank bills. The IMF advises putting into place a medium-term debt management strategy that increases fund raising efficiency, reduces costs and keeps the risk levels associated with the debt down, especially if the country is to issue an international bond.
Diversification is a priority. The government needs to get more paper in the hands of retail, small commercial and foreign investors. Non-competitive bidding would appeal to the non-professional investors, the World Bank says. A secondary bond market is also a priority, so that liquidity can be brought to the market. This will require effective supervision and good compliance standards and a reporting system for trades made OTC to promote transparency and good pricing. The World Bank would like to see intermediaries begin to act in the capacity of market-makers.
The World Bank suggests a consolidation of government debt lines, with a retirement of the more illiquid of them, and the selling of longer-dated securities to institutions in need of these investments to match their obligations. The World Bank is advising the central bank to begin to undertake buy-back and switch operations. They would allow the bank to replace illiquid bonds with more liquid paper, which would improve trading and aid in the creation of benchmark issues. It has also advised the use of syndication for the sale of government securities.
An international bond has been suggested as well. It is seen improving the operations of the debt market and helping the country defend against liquidity shortfalls should they occur in the domestic market. An international bond will also allow PNG to create a benchmark for future financings. The country is in a unique position as a so-called blend economy. It can avail itself of concessional financing while at the same time tapping the international markets on a commercial basis. With an international issue, the country might become qualified for inclusion in international bond indexes, which require a certain amount of debt outstanding and the achievement of certain operational performance levels.
Several steps could raise the likelihood of international investment. In addition to the introduction of a non-competitive auction process, the World Bank has advised the improvement of information dissemination, the holding of international roadshows and the establishment of automated clearing and settlement. In specific, the central bank has been advised to work with Austraclear to develop an electronic market infrastructure. “A sovereign bond would help,” Mark Baker, managing director PNG at ANZ Banking Group, told OBG. “Electronic trading would be fantastic.”
