The Australian Office of Financial Management was in the news last week with the focus being on the massive funding task that it has in front of it. With $86 billion of CGS currently outstanding, AOFM needs to increase this amount to $200 billion by the end of fiscal 2011, and further from there.
Neil Hyden, CEO of AOFM, said AOFM is far from reaching the limit of investor appetite for Australian sovereign debt. And this is indeed borne out by the level of oversubscriptions seen in AOFM's twice-weekly bond tenders to date.
Further, to assist with the new debt sales process, AOFM has said it intends to introduce a new 2022 bond and will consider issuing some even longer dated bonds. New inflation-linked issues may be part of the mix too.
In fact, the issuance of longer dated bonds is going to be critical to AOFM's and the government's success. At the moment, the longest dated bond is the April 2020 and there is a practical limit as to how much further existing benchmark bond lines can be expanded.
For one thing, investor appetite for increased exposure within current maturities will be sated eventually, and secondly, AOFM needs to consider how it manages the Australian government's debt maturity profile. With the volume of debt outstanding set to significantly increase, the government's debt maturity profile needs to be expanded to avoid having to roll over too much debt in any one period.
As it is, AOFM's website reveals that the government has more than $15 billion of debt maturing in 2010-11. This is only two years away, and it is more than twice the volume of debt maturing in any other year, with the exception of 2020-21.
Australia is something of an anomaly among other economically advanced nations in having such a limited government yield curve. Government yield curves out to 30 years and even longer are more the norm.
The introduction of an Australian long bond with a term to maturity of, say, 30 years, would have rarity value among investors and therefore should attract strong demand, as would any other new bond issues that would fill in the gap between this new long bond and existing benchmarks. The caveat is that all new issues must be of benchmark size.
Leaving aside international investors, there should be solid demand for such bonds among our domestic superannuation funds and retirement income providers. It is well recognised within the industry, and even by the government itself, that there is a need to develop long-life annuity products to fund the retirement of a longer living population.
Such products don't exist at present and this is, in large part, due to there being no risk-free asset on which to build the products. Inflation linked bonds would be ideal for this purpose but, given that this is a market that is only just starting to develop, demand for inflation-linked bonds is likely to be limited, at least initially.
Inflation-linked bonds also have a disadvantage for governments in that they are expensive - the long-term cost of debt servicing cannot be inflated away. Longer dated nominal bonds are also relatively expensive, given a normal shaped yield curve, but this is mitigated by the typical flattening of the long end of the curve. Moreover, there may never be a better time to lock in interest rates on 30-year debt.
There is a place for some inflation-linked bond issuance but the issuance of longer dated nominal bonds will meet with broader based investor demand and best meet the funding needs of the government. Any shortage of inflation-linked bonds for the creation of long-life annuity bonds can be compensated for by using 30-year bonds in a well structured portfolio that includes high quality equity assets.
Consideration also needs to be given to the funding needs of the large scale infrastructure projects that the government wishes to pursue. The government has announced its intention to issue 'infrastructure bonds' to meet some of these funding requirements. Unless these bonds are linked to specific projects, is there any need to fracture the market with the introduction of a bond that differs in name only?