A key role of the Finance Ministry is to fund the budget deficit. Within that role not only do they have to secure the funds, but they also must put equal emphasis on reducing the cost of borrowing. In this article, I want to share my thoughts on how the government can reduce funding costs.
Issuing shorter-term instruments at peak rate cycles and longer-term during low interest rates
When interest rates are very low and expected to increase, the prudent approach is to borrow using long-term instruments. The opposite strategy makes sense when rates are very high and expected to come down. Recently, Mr Ahsan Mansur, the governor of Bangladesh Bank, communicated that he expects inflation to drop to about 7% in say six to seven months from the current double-digit number. In such a situation, the smart approach should be to borrow using treasury bills, particularly 91-day bills.
Since we have an upward-sloping yield curve at the moment, borrowing short-term has both immediate and long-term savings. (See Figure 1)
Issuing more Shariah-compliant government securities
Bangladesh has a huge demand for Shariah-compliant debt securities such as Sukuk. The demand comes from both Shariah Compliant banks and financial institutions as well as retail investors. When demand outstrips supply, pricing is very favourable.
A simple tactic to reduce borrowing costs would therefore be to issue more Shariah-compliant instruments. To date, the Bangladesh government has issued four such Sukuks with the latest one in June 2024. The proceeds for the latest one were to be used for the Upazila and Union road network in Chittagong. The total issue size was Tk10billion. Previously three other government Sukuks were issued with a combined size of Tk180bn.
These issues were heavily oversubscribed even though investors barely knew about the issuance. A little bit of marketing could lead demand to simply explode and allow large amounts of funding at a lower cost than the conventional borrowing instruments.
An added benefit would be the creation of a bond market and perhaps even better asset allocation for the country.
Shifting the yield curve down
The yield curve (shown above) is created by the intersection of demand and supply for government securities at different maturities. A lower yield curve implies lower borrowing cost at all maturities.
One way to reduce the curve is by reducing the government's borrowing needs. This is something the interim government has already announced as an agenda. The other way is by increasing the money supply. This way is not feasible at the moment given the high level of inflation and the targets on the monetary base set by the IMF. There is however a third way.
Top-quality private commercial banks are offering fixed deposits at 10.5% while the government is offering risk-free securities at 11.8% for a similar tenor. This defies the laws of finance and economics and is happening because of a distribution and literacy problem for the masses. By investing a bit of time and effort the literacy and distribution problem can be solved. The benefits of educating the masses are extraordinary and even without doing much analysis, I feel the ROI of any investment in education would be more than 100x. This is because the reduction in cost for the government will be perpetual.
Here are some high-level recommendations to solve the distribution problem.
a. Make the process of buying treasury securities simpler:Currently investors can buy bills and bonds using BP (business participant) accounts. The BP process is lengthy and cumbersome and existing players are broadly not very keen to provide this service. BO (Beneficiary Owner) accounts on the other hand don’t allow purchases of treasury bills, and some other bottlenecks need to be addressed.
b. Make fixed-income mutual funds popular: Most average investors would find participating in bond auctions complicated. Hence going via an intermediary like a licensed asset manager is probably the best way for the intermediation problem to be solved. Fixed-income mutual funds are rapidly growing in popularity and some government support in this segment could help in growing this rapidly. The regulator only has to ensure governance and trust.
c. Make treasury securities the most popular borrowing method instead of Sanchaypatra: Sanchaypatra has a wide distribution network currently via post offices, BB, and bank branches. In contrast, treasury securities are purchased by bank treasury teams that don't have the bandwidth to deal with mass retail customers. Sanchaypatra had many downsides including a higher borrowing cost (adjusted for the tax benefits), lack of planning (the government can determine auction size on treasury bills and bonds but not for Sanchaypatra) and benefits often going to the wrong recipients. It also distorts the interest rate market and has been a major barrier to the development of the bond market.
Sanchaypatra needs to go through some reforms such as market-linked rates instead of the present fixed rates. It also needs to target the beneficiary group better.
Meanwhile, the government needs to work hard to make treasury securities the most popular form of borrowing. The distribution channel for treasury securities should be better than Sanchaypatra.
d. Invest in financial literacy to remove misconceptions: A lot of work needs to be done on educating people about the risks of investing in different fixed-income assets. Very few people in Bangladesh understand that treasury securities and Sanchaypatra have the same levels of credit risk and are both safer than fixed deposits in commercial banks. These misconceptions need to be addressed through a concerted literacy campaign.
Asif Khan, CFA is the Chairman of EDGE AMC Limited and President of CFA Society Bangladesh.