Secondary transactions of tradable fixed income securities of the government in recent months have witnessed a sluggish trend. It is the demand in the market which ultimately determines the volume of transactions, and hence the sluggish trend may reflect some message regarding the monetary management of the government.
Currently, there are two types of tradable government securities and these are all fixed income in nature. One is short-term fixed income securities and known as treasury bills. Another is treasury bonds and these are long-term government securities. There are also a number of non-tradable securities, including sanchaypatra or savings instruments.
Latest statistics of the central bank showed that the secondary trading of both the treasury bills (t-bills) and bonds (t-bonds) have declined sharply in the first eight months of the current calendar year. During the January-August period of 2018, total value of the secondary transactions of t-bills and t-bonds stood at Tk 84.01 billion. The value was Tk 219.39 billion in the same period of the past year. Thus, secondary trading of these government securities dropped by 62 per cent during the period under review.
Government uses these securities to borrow money from the financial market, from the banks and financial institutions to be precise. Banks and financial institutions purchase these securities through regular auctions and also trade the purchased debt instruments among themselves later. The former is primary market activity and the later secondary market activity.
In Bangladesh, primary dealers (PD) are authorised to take part in auctions conducted by the central bank. Other institutions and individuals can also participate in auctions but through the PDs. At present, 21 banks are operating as PDs. They are generally registered entities with Bangladesh Bank and have licence to buy and sell the government debt securities. They buy these securities directly from the Bangladesh Bank which is responsible for issuing these fixed income securities on behalf of the government. After purchase of the t-bills and t-bonds, they can resell them to other buyers. Through this process, the PDs actually function as a market maker for the government securities.
But it is not the PDs, but the central bank which makes the decision to borrow from time to time. The government borrows from the financial market to finance the budget deficit. Besides, revenue earnings, the borrowing is another option for the government to run its development and revenue expenditures. There are also two sources of the government borrowing: domestic and foreign. Two types of domestic borrowing are there: bank and non-bank. T-bills and t-bonds are used to borrow from the banking system.
While borrowing from the banks, a dilemma for any government is whether such borrowing makes any crowding out effect to the private sector. If government borrows heavily from the banks, there is little room for the private sector to obtain its required credit. The loans become costlier as banks charge interests with higher rates due to limited funds against high demand from the private sector. To avoid such crowding out effect, the government looks for non-bank borrowing though the so-called crowding out effect is less visible here.
In Bangladesh, non-bank borrowing is costlier in terms of interest payments. Currently sanchayparta or National Savings Directorate (NSD) certificates are the major tools for the government to borrow money from the public. The annual yield rates of savings certificates are quite high, more than 10 per cent on average. So, these are very popular among the people and they rush for these to get good returns compared to lower interest rates on bank deposits.
In the past fiscal year, non-bank borrowing of the government stood at Tk 474.90 billion in net terms (after adjusting repayments of principals against the gross sales of the savings certificates). So the budget target of Tk 461.00 billion was exceeded by a small margin. At the same time, net borrowing from the banks actually declined by Tk 286.63 billion (net borrowing turned negative after adjusting the repayments against the borrowed principal amount). Budget target of the net bank borrowing was Tk 199.70 billion. It means that deficit financing from the domestic sources is heavily reliant on non-bank borrowing, savings certificates to be precise.
As the government has reduced its borrowing from the banking system, the requirement for issuance of t-bills or t-bonds also declined. The central bank data showed that the government did not issue any t-bill or t-bond since October, 2017. During the first four mounts (July-October) of FY18, total value of the primary issuance of t-bills and t-bonds stood at Tk 227.0 billion against the annual issuance of Tk 719.82 billion in FY17. Thus, the primary issuances of the government's tradable securities decline by around 69 per cent in the past fiscal year.
The decline in primary issuance of t-bills and t-bonds also contributed to the reduction of the secondary market activities of these securities. In the absence of fresh securities, market players may be less interested on trading the existing securities due to lower yield rates.
But the sluggish transaction in the secondary market of the government securities has much more to do with primary issuance. Despite the presence of secondary market, the securities are not immediately 'liquidable'. An investor may find it difficult to encash his/her bond holding as and when required. He/she may even have wait for a few days to find out the desired buyers in the market. PDs are also holding some of the securities they have already purchased and not trading these regularly.
Pricing mechanism of these bills and bonds in the secondary market is also complex and not easily available to the investors. They need to know very clearly about the pricing mechanism. For instance, a t-bond may be sold at the secondary market in discount (lower rate of yield than initial or coupon rate) or premium (higher rate of yield than coupon rate). Discount or premium depends on several factors of the market and investors need to understand all these fundamentals .
Another factor deterring investors from buying government bond is higher profit rate on saving certificates. While average interest rate on 10-year t-bond is around 7.50 per cent on maturity, a three-year NSD certificate gives 11 per cent return on maturity. No sensible investor will go to purchase a long-term government bond when higher return is available from medium-term non-tradable securities.
Against this backdrop, decline in the secondary transaction of t-bills and t-bonds indicates a kind of distortion in the financial market of the country. It also reflects lack of interest of the policymakers' in revamping the secondary market mechanism for bonds or debt instruments.