Analysis: What’s the Fuss About? Australia’s True Cost of Additional Debt is Just 10bps
- Published on
- 30 Apr 2020, 06:44 PM
By Sophia Rodrigues
The Australian government has borrowed around A$25 billion extra this month to meet its COVID-19 related spending needs and the interest expense on that borrowing is a record low 10 basis points or even lower, not the issue yield of 0.25%-1.07%
This is because the Reserve Bank of Australia is pursuing unconventional monetary policy by making bond purchases in the secondary market at the same time as the government stepped up its borrowing.
So long as the total bond purchases of the RBA is equal to or greater than the size of the government’s additional borrowing, the interest cost would be 10bps or lower.
That cost would have been zero if the RBA has retained the width of its corridor system for overnight rate. Instead it narrowed the corridor, so interest rate on Exchange Settlement balances would be 10bps.
A zero cost would have been no different to the RBA directly monetizing the government debt. A 10bps (or lower) cost is nearly the same as direct monetization, except that it is done indirectly through the secondary market and the RBA doesn’t like to think of it as monetization.
TRUTH, BUT NOT ENTIRE TRUTH
Governor Philip Lowe used a recent speech to once again convey his thoughts on this, “I would like to restate that we are buying bonds in the secondary market and we are not buying bonds directly from the government. One of the underlying principles of Australia's institutional arrangements is the separation of monetary and fiscal policy – that is, the central bank does not finance the government, instead the government finances itself in the market.”
Lowe further said this:
“While we are not directly financing the government, our bond purchases are affecting the market price that the government pays to raise debt… but our actions should not be confused with the Reserve Bank financing the government,” he said.
But what he cleverly avoided was saying that the total impact of bond purchases was not just through the market price but also the coupon that the RBA now gets for the bonds it holds.
DON’T FORGET GOVERNMENT OWNS RBA
When the RBA buys bonds from the secondary market, it basically creates money out of thin air. The cost of that money is zero.
Once the RBA owns the bonds, it receives coupon on them. The coupon on these bonds range from 2.0% to 5.75%, and this is the amount it will receive.
The coupon is paid by the government to the RBA, but the RBA is actually owned by the government, so the coupon which is technically a surplus for the RBA will be paid back via dividend.
The government will thus receive back what it pays as interest expense.
There are other technicalities here about cashflow, coupon, issue yield and interest payments which I have avoided to keep this simple.
So far in April, the Australia Office of Financial Management has issued around A$25 billion of more bond than it had previously planned, with more done through Treasury Note issues.
On the other hand, the RBA has bought around A$40 billion of Australian government bonds via its bond-buying auctions.
MORE PURCHASES THAN JUST VIA AUCTIONS
In addition, the RBA also buys bonds maturing within the next year or so from the secondary market to reduce the impact on the market from a huge bond repayment. That buying is normal, and also done by the AOFM.
But since the RBA started conducting bond-buying auctions, the AOFM has said it will no longer do those purchases. So, the RBA will now do those additional purchases too.
These extra purchases will also result in additional interest payments to the RBA, which will go back to the government.
The cost to the RBA is the interest rate on the ES balances which have risen due to several reasons, including the bond purchases.
That interest is the only true cost of the additional government debt, and it will remain the only true cost till the RBA holds these bonds in its books.
--Contact: Sophia@centralbankintel.com