DMO likely to increase bond tender size to $350m

Data Flash (New Zealand)
DMO likely to increase bond tender size to $350m

The Government will publish its December Economic and Fiscal Update on 18 December. The document is expected to show a downward revision to the growth outlook for 2002 and, consequently, weaker projections for the fiscal balance in 2001/02 and 2002/03.

Our calculations suggests that the cash flow for the current fiscal year (ending in June 2002) will be around $300 million below the projections published at the time of the Budget last May. For next year, the difference could be up to $1 billion.

In addition to the $300 million shortfall for 2001/02 arising from a weaker economy, the Government has to fund its $885 million investment in Air New Zealand.

The capital contingency provision for the current year is only $315 million, which leaves around $900 million of extra funding requirement. Several options exist:

Cover the shortfall entirely through extra bond issuance; Put seasonal T-bills back in the market and delay some of the net fx debt repayment that was planned for this year; or A combination of the two strategies.

It should be noted that the funds earmarked for the Government's new superannuation scheme provide only temporary relief. While currently around $50 million per month are earmarked as contributions to that scheme, the infra-structure for managing the funds is not in place yet. As a result, the money is currently invested by the DMO (Debt Management Office) and can be used to cover a general funding shortfall. However, as soon as the super scheme is fully operational, the Government will have to hand over the funds to the appointed private sector managers. That is expected to happen before the end of the fiscal year, thereby adding to the funding squeeze at that point.

The Government's decision on whether to increase the remaining six bond tenders in H1/2002 to cope with the increased cash requirement for this year is likely to be influenced by the outlook for 2002/03. Budget documents showed a projected tender programme for that year of around $4.5 billion, an increase of $1 billion from the current year and far above the average of the 1990s.

With the cash flow likely to be significantly reduced in 2002/03, that funding requirement could easily reach $5.5 billion. Again, a combination of other funding methods could be used to reduce this to around $5 billion, but that would still leave the average size of the tenders in excess of $400 million. We believe that the Debt Management Office will want to avoid such a step increase in tender size from one year to the next and will opt for increasing this year's issuance and carrying some of the funds forward into 2002/03. There is the risk of bond spreads widening at a time of an already high New Zealand risk premium. However, the DMO is likely to take comfort from the fact that such an effect was short-lived following the recent announcement of extra bond supply from the liquidation of the GSF bond portfolio.

The Government is likely to prefer a strategy of smoothing the increases in bond tenders from a political perspective. Announcing a large increase for the 2002/03 tender programme at the time of next year's Budget would most likely overshadow the positive PR that is desired for an election year Budget. An excessively large increase in the borrowing programme would also revive the debate about the Government's debt funding of its increased contribution to the new superannuation scheme.

While the increase in the size of the remaining tenders for the 2001/02 year could potentially receive a similarly negative response, the Government can attribute it easily to the Air New Zealand bail out which is fresh in people's memory.

In conclusion, we expect the six bond tenders in H1/2002 to be increased by $50 million from current tender sizes to $350 million.

Ulf Schoefisch, Chief Economist, New Zealand

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