TB auction exposes default risk fears

Last week the Reserve Bank of Zimbabwe (RBZ) made its first attempt since dollarisation to auction treasury bills (TBs).

Report by Collins Rudzuna

Bids were invited for an issue meant to raise US$15 million.

According to terms set out, the TBs would have no buyback feature.

Reports say bids totalling US$7,7 million were received, with rates ranging between 5,5 and 15%. Apparently all the bids were rejected, effectively making the TB issue a failure. Normally, TBs are an important way for governments to raise short-term funds and failure by our government of this first attempt at issuing United States Dollar-denominated bills deserves scrutiny.

In examining the RBZ’s TB issue it is important to first set out key features of TBs. The first and perhaps most important one is that TBs are normally considered free of default risk.

Those who buy the bills are lending to government, an institution which cannot default because it has the last ditch option of simply printing money to repay if it has to. Zimbabwe is, however, in the peculiar position where because we use foreign currencies, treasury does not have the power to print money.

As such, a TB issue denominated in any of the foreign currencies we use does not have the default-free feature. By issuing TBs under current conditions the RBZ is essentially looking to borrow on government’s creditworthiness as would any other private borrower in the market. We suspect the auction was not fully subscribed because the creditworthiness of the government in its present state is open to doubt.

Another important characteristic sometime added on to TBs that make them more liquid and hence more attractive to potential investors is the addition of a buyback feature. This is an undertaking by the issuer that the bills can be bought back before they mature.

A buyback feature allows lenders to liquidate their bills should they have an unforeseen cash need before the stated 91-day maturity period. An alternative way to make the bills liquid would be to allow them to be tradable on the secondary market. It appears the bills issued by RBZ last week were not tradable on the secondary market and would have to be held to maturity.

Perhaps there was just not enough information disseminated in time before the auction. Market players were perhaps caught unprepared.
The points discussed above may help explain why the bids tendered fell short of the US$15 million originally sought. Yet the bids for US$7,7 million that were tendered were rejected despite having rates as low as 5,5%. If this situation shows that the RBZ is looking to borrow at a cost below 5,5% then the expectation is clearly at odds with the yields that market participants are looking to get.

Especially for smaller banking institutions, the cost of funds is too high to justify placing money at such low rates. As long as foreign investors place a sovereign risk premium on Zimbabwe we will continue to have a high cost of funds.

Perhaps the RBZ was hoping for tenders around 2%, which would match the rate on statutory reserve bonds.

Shortcomings mentioned above aside, we expected a TB issue to be well-supported as there is appetite in the market from institutions like pension funds, that have to hold what are designated ‘prescribed assets’ as part of their portfolios. Treasury bills would normally qualify as prescribed assets. There are not enough prescribed assets that have been issued lately and most of those who are supposed to hold them have less than the legal requirement and therefore could be expected to be keen to comply.

So does the failure of the RBZ’s first post-dollarisation TB auction signal that government is incapacitated to borrow? Or are there measures that could be put in place to ensure that future auctions find support? The failed auction is not nearly as dire a development as it may seem if corrective measures are put in place. First would be the restoration of confidence in government’s creditworthiness. To achieve this there would be need to improve the perception of government’s major conduit of borrowing, the central bank.

Past obligations that are still outstanding such as the gold bonds, which have been rolled over instead of being honoured at maturity, would have to be settled somehow. Understandably, the central bank is not able to honour these bonds it does not have enough money.

Perhaps government should just bite the bullet and avail the money for these bonds. This would be helpful as the RBZ would be in a better position to raise money for government if it is seen as having a low default risk itself. The counter argument would be that government is already burdened with many projects which need money. However, it would make sense to sacrifice money now to enable future capital raising exercises.

A more lasting solution would be to put in place measures that will eventually see Zimbabwe using its own currency and having the flexibility to create money but within responsible limits.

Hyperinflation is still fresh in the minds of Zimbabweans and most would cringe at the thought of printing our own currency again. But it should be remembered that for any central bank to function normally it must be empowered to do so and entrusted with certain responsibilities, including that of issuing currency. Restoring this function would automatically bring back confidence in the ‘default-free’ feature of TBs as lenders will know that as a last resort the central bank could simply print the money to settle government maturities.

 

Realistically, however, the prospect of having our own currency again is still very much far off.

In the meantime if government is desperate for money it will probably be forced to accept expensive money like any other borrower.