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Strategies for Reducing Government Funding Costs: Insights for the Finance Ministry

By Asif Khan, CFA

Chairman

EDGE AMC Limited

Posted on: 25 Aug, 2024

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 ensuring the funding cost is low. In this post, I want to share my thoughts on how government can reduce funding costs.

1. Issuing shorter-term instruments at peak rate cycles and longer-term during low interest rates: I have widely covered this in previous posts. Fortunately, I am noticing a clear shift in the issuance patterns where the treasury is raising significantly more sums via the 91d instrument than the longer-term ones. 91d bills right now yield almost 100 bps lower than a 5-year bond.

2. Issuing more Sukuks: The government of Bangladesh has issued around 4 Sukuks till date. There is a big demand for Shariah-compliant bonds in Bangladesh as investors struggle to find safe issuers. Increasing government-issued Sukuks will reduce borrowing costs for the government, increase the depth of the bond market, and allow a significant group of people to invest.

3. Shifting the yield curve down: The yield curve is created by the intersection of demand and supply for government securities at different maturities. One way to reduce the curve is by reducing the government's borrowing needs. This is something the government has already announced. The other way is by increasing the money supply. This way is not feasible at the moment. HOWEVER THERE IS 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 is illogical and is only happening because of a distribution and literacy problem for the masses. By investing a bit of time and effort in this literacy and distribution problem can be solved and the benefits of this in terms of present value terms will probably be 100x larger than the costs.

Here are some high-level recommendations to solve the distribution problem.

a. Make the process of buying treasury securities simpler. The BP ID process is lengthy and cumbersome and existing players are broadly not very keen to provide this service. BO accounts currently don't allow treasury bill purchases which needs to be solved also.

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.

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.

d. Invest in financial literacy to remove misconceptions. Many people believe bank deposits are safer than government-issued securities.