“Paul Davis did not tell the people of this province that we could not borrow long term money. That’s the situation we are currently facing in the province….” - Premier Dwight Ball (VOCM Open Line February 2-, 2016)
I wasn’t
sure that I had heard the Premier right; I waited until VOCM had posted Paddy
Daly’s Open Line Show on its archive and listened again, and again. Indeed, he did say it:
“… we could not borrow long term money…”
Ball seemed apprehensive, even scared. Later, I wondered if he fully understood the
implications of what he had said.
This may seem, to some, a very complex issue; but that is true only in its detail. Most people would understand the implications of having their credit card taken away.
A couple of
points are in order:
First, the Government
can only borrow long-term debt after a money Bill has been passed by the House
of Assembly. When the limit cited in the Bill has been reached, the Government must
return to the House and seek approval before borrowing more. I
wondered if Ball was confusing the legislative requirement with issues pertaining strictly to the bond market.
Secondly,
there is nothing new or unusual about Government’s use of “short-term” 1, 3,
and 12 month Treasury Bills, known as T-Bills. Short-term debt instruments help
large companies and governments manage their Treasury functions, especially those who have uneven revenue streams during the year, as all governments do. When
the amount of short-term debt grows unwieldy or too expensive, the long term
debt market is tapped. The most favourable timing is identified by the
Government’s financial advisers for liquidity (availability of capital) and
the most favourable Coupon (the interest rate).
Right now,
short-term money is cheaper than long-term; but borrowing large amounts via short term T-Bills, as this province is now doing, isn’t without risk.
The global economy is overshadowed by many black swans; there is always danger the rate of interest on short-term Notes will shoot up or the government
is forced to pay more for bond funding than it had planned, which impacts the
current account.
Already forgotten is the melt-down of the American
economy, in 2007-8, when short-term liquidity, among the banks, dried up.
CBC reporter
Peter Cowan tweeted on Tuesday, February 23rd, 2016 that the
Government “in the last 3 months issued 3 and 31 year bonds totalling $535
million”. The information, he said, had
come via the Finance Department. Cowan added a qualifier in his tweet: the “Province
finds "long-term
borrowing difficult" but (it is) still able to raise some money”.
Such an
appraisal of our ability to borrow does not exactly constitute a comfort
letter. But, it means Ball was only partly wrong, just barely, about the
province’s long term borrowing capability.
Sources familiar
with the issue explain that the Canadian bond market, especially for the smaller
provinces, is very “illiquid”, right now. Not just Newfoundland and Labrador,
but at least two other provinces have not completed their long-term borrowing
programs, this year. The situation, in part, maybe a matter of timing and
strategy; every borrower wants the lowest possible rate of interest. But, it is
clear that provinces, especially the smaller ones, will have to check their appetite
for debt.
An illiquid bond market is due, in part, to historically low interest rates.
Investors, especially income and pension funds, are reluctant to commit large
capital sums, long term, given the paltry returns. Long term rates for
provincial bonds hover around three percent. CBC's Peter Cowan noted that this province had borrowed 31 year money, recently, at 3.3%.
Not surprisingly, U.S./Can. currency
fluctuations are not helping this market, either.
Interest rate
spreads (interest rate charged by banks minus the deposit rate) are also low;
ultimately, buyers and sellers will determine bond yields, but investors are not taking on large risks for little return.
On average,
provincial bonds have a yield of about 100 basis points (equal to 1%) higher
than more secure Federal Government debt.
The problem is, as one source describes, liquidity for NL bonds is worse than for other
provinces, meaning there is limited capital
available for NL bonds and the pool of traders, in NL bonds, is also small. Bonds are traded much as equities are; institutions need to be able to adjust their portfolios which illiquidity would prevent.
The fact that this province has been absent from the bond market for several years, owing to its recent brief flirt with wealth, doesn’t help. And, neither does provincial indebtedness, which as a percentage of provincial GDP, is on the rise and a warning to the risk averse.
The fact that this province has been absent from the bond market for several years, owing to its recent brief flirt with wealth, doesn’t help. And, neither does provincial indebtedness, which as a percentage of provincial GDP, is on the rise and a warning to the risk averse.
Like the
stock market, however, the bond market is all about risk and reward. It is not hard to
see in what direction the Province’s cost of borrowing is headed.
NL is experiencing a
financial “perfect” storm, exemplified by a collapse in oil prices and a $2
billion operating deficit. A potential sinkhole at Muskrat Falls is made worse
by a diminishing electricity demand curve and an ageing demographic. Lenders want
all major risks quantified. A likely downgrade of the province’s credit does
not constitute a magnet for capital, either. NL won't even qualify for equalization for at least four years.
Cheap long term money will be hard to come by.
Cheap long term money will be hard to come by.
All that said, the
Province is “rolling over” short term T-Bills of around $2 billion. A new
fiscal year begins in only six weeks. An additional sum, at least $4 billion,
possibly more, (ask Nalcor CEO Ed Martin) will have to be
borrowed.
When so much short
term debt must be “rolled over”, every three months, there is a big concern of a
hiccup in the world economy, a further decline in government revenues (i.e.
HST and oil royalties), or a downgrade by the rating agencies will reduce, even
further, the province’s access to the long-term debt market.
But even illiquid
markets can be greased. The issue isn’t (at least, not yet) whether the
Government can borrow, as the Premier has stated. The question is: what rate of interest is the Government prepared to pay to get investors to loosen up?
Likely, this question is inseparable from the fundamental issue of Ball's own political leadership. Access to the bond market will widen only if his Administration is capable
of addressing, immediately, our budget deficit; if it has a plan, and can demonstrate it is committed to achieving fiscal balance within a reasonable
period of time.
A failure of leadership risks means an illiquid bond market will be closed.
Premier Ball ought
to have known, and his officials ought to have warned him, there is no room for
half statements on matters having a direct bearing on the Province’s fiscal
integrity.
Yet, confused as they seemed to be, his remarks
serve as one more warning of difficult choices.
Ball and his Minister
of Finance have six weeks to polish their articulation.
The bond market will be expecting more clarity than the Premier offered Paddy Daly.
