This article first appears on The Guardian website at this address: https://www.theguardian.com/business/2016/sep/22/why-the-turnbull-governments-plan-to-issue-30-year-bonds-is-an-unnecessary-risk
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Why the Turnbull government’s plan to issue 30-year bonds is an unnecessary risk
The Turnbull government has indicated that it will start issuing 30-year government bonds.
In layperson’s terms, this means the government will be borrowing money for a 30-year fixed term, paying interest every six months over those 30 years to the holder of those bonds. This locks in interest payments as a part of the budget bottom line right through to 2046 and probably beyond. The government will use the revenue from those borrowings to fund the budget deficit and maturities of existing bonds. The deficit continues to hold at levels well above the levels the Coalition government inherited from the Labor party when it won the 2013 election.
The decision by the government to borrow money for such an extended duration – via the Australian Office of Financial Management (AOFM) – sits oddly with the rhetoric from Malcolm Turnbull and Scott Morrison about their core objective of “budget repair” and the goals of returning to surplus. If these objectives were genuinely part of the government’s economic strategy, there would be no need to borrow money for 30 years. The current 25-year bonds are more than sufficient to cover the government’s deficit requirements, especially if the projections for a return to surplus in about three years are still relevant.
The AOFM, as manager of the commonwealth’s debt, has as its objectives to “promote the integrity of Australian government securities (government bonds)” and “cost-effectively manage the risks” of borrowing.
It has met these goals over many decades. The AOFM has never failed in a bond tender. It markets the virtues of the Australian economy to investors, which has helped to lower the average borrowing cost of government debt. The fact that Australia’s credit rating has been so favourable over many years has also helped the AOFM to meet its goals.
Most other major industrialised countries issue 30-year government bonds. One reason is the level of government debt in those countries. The G7 countries have government debt levels generally between 50% and 150% of gross domestic product with an average around 90% of GDP. This requires a large borrowing program over both the short, medium and long term. Australia’s level of net government debt is currently around 17% of GDP and is forecast to peak under 20% of GDP before falling within two years as the return to surplus looms. The likely borrowing program for the AOFM is forecast to shrink as the budget deficit narrows from $37bn in 2015-16 to $26bn in 2016-17, $15b in 2017-18 and to under $6bn in 2018-19.
The need for a 30-year government bond is, at best, problematic. The AOFM can cover the near-term deficits by borrowing over a shorter duration.
There is a risk that in issuing a 30-year bond the AOFM is borrowing money that the government will not need. If, as is increasingly likely, the budget deficit narrows as currently forecast and the surpluses in the early years of the 2020s turn out to be substantial, the government will have borrowed money that ends up sitting on deposit at the RBA, funding nothing while all the while requiring the government to pay interest.
A more measured approach would be to maintain the existing borrowing profile and continue to fund the budget requirements from shorter duration borrowings. Only if the budget deficit profile deteriorates over the medium term would there be a legitimate need to consider extending the term over which the government borrows.
There is no significant investor demand for 30-year Australian government bonds, something acknowledged by the AOFM. It is taking a risk by issuing 30-year bonds at a time when markets are relatively calm. It could prove to be costly. The first few bond tenders for the 30-year bond will be watched closely for the yield the government will need to pay and the extent of investor interest.
