Topic 6 – Government Debt, Monetary Policy and Payment System Flashcards
Why Do Governments Need to Borrow?
Governments need to fund capital and recurrent expenditures.
- This is achieved by issuing debt securities in the money and capital markets.
Fiscal policy
relates to the annual incomes and expenditures of a government.
Monetary policy
affects the level of short-term interest rates by adjusting the level of financial system liquidity.
The borrowing requirement over a Full Financial Year:
To finance budget deficits.
Rollover existing bonds that mature.
Retire debt at/prior to maturity if budget is in surplus
Crowding-out effect
- Government demand for debt financing reduces amount of funds available for investment in private sector.
- Minimized in times of strong fiscal management, i.e. budget surplus
T-Bonds issued are held by market participants for a range of reason including
Liquidity management Portfolio investments Risk management Payments system requirements Prudential requirements
The borrowing requirement Within the Financial Year
Borrow to finance short-term mismatches between receipts and payments, i.e. manage day-to-day liquidity.
Rollover existing debt.
Instruments issued for intra-year budgetary purposes
are short term, i.e. Treasury notes (T-notes).
Main Feature of T-Bonds
- Coupon instrument).
- Coupon payment = coupon rate x face value of bond.
- Face value of bond redeemed at maturity date or may be sold in secondary market for early redemption.
Who buys Treasury Bonds?
RBA Commercial Banks Life insurance offices Other private financial institutions State governments
T-bonds Primary Market Transactions
Issued by Commonwealth Treasury.
Australian Office of Financial Management (AOFM) holds the tenders
Tender System
Investors bid a price on government securities, thus setting the yield; allocated in order of lowest yields
Australian Office of Financial Management (AOFM)
A body established to manage Commonwealth government debt issues
1982–present, tender system
- Bids submitted through AOFM;
- Minimum $1 Million;
- Bids made in terms of yield to maturity up to three decimal places – not in terms of price;
- Bids accepted in ascending order of yield, i.e. lowest-yield bid (highest price) first, until issue fully subscribed;
- Settlement is via Austraclear.
Why does RBA buy treasury bonds
to change the level of financial system liquidity by either buyin or selling government securities to other investors
Financial System Liquidit
The amount of exhange settlement accounts in the system
Why do banks buy treasury bonds
To manage their operational and prudential liquidity
The hold bonds as part of their liquidity management strategy
Operational Liquidity
Access to funds to meet day to day expenses and take advantage of business opportunities
Prudential Liquidity
Liquidity held above operational liquidity needs; may be prescribed by a regulator
T-Bonds: Secondary Market Transactions
On Exchange
Over-the-counter
On exchange transactions
Buying/selling securities on a formal exchange such as stock exchange
Over-the-counter transactions
buying/selling of securities conducted directly, no formal exhange, normal in between institutional investors
Individuals and institutions may participate in the secondary market for the following reasons
funding requirements liquidity needs reserve requirements interest rate expectations to maintain the maturity profile of a bond portfolio.
T-Bonds Pricing:
𝑷=𝑷𝑽𝒄+𝑷𝑽𝒇
𝑃𝑉𝑐 = PV of the coupons; 𝑃𝑉𝑓 = PV of the face value of bond.
T-Notes
T-notes are short-term discount securities issued by the Commonwealth Government through the Australian Office of Financial Management (AOFM).
T-notes Tendering Process
- Tenders held periodically on a competitive basis to meet funding needs.
- Minimum parcel of $1 million face value
- Bids accepted in ascending order of yield, i.e. lowest-yield bid (highest price) first, until issue is fully subscribed.
- T-Note purchases are settled using the Austraclear settlement system.
State Government Securities
Each state has formed a central borrowing authority to facilitate debt management programs
Issue similar securities as the Commonwealth, i.e.
- Medium-term notes and longer-term bonds (referred to as semi-government securities)
- Discount securitiesI
The RBA, in determining its monetary policy stance, strive to achie
stability of the currency
maintenance of full employment
economic prosperity and welfare of the Australian people
By impacting on the cash rate (overnight interbank rate), the RBA can affect rates of longer term securities, e.g.:
RBA tightens monetary policy by selling Commonwealth Government securities (CGSs) and reducing the money supply.
This causes investment and household spending to decrease.
In reviewing monetary policy settings, some of the important underlying indicators considered by the RBA include
IR IR for borrowers ER Unemployment Economic productivity and capacity Trends in asset values International monetary and economic conditions
Open Market Operations
Actions of the reserve bank in the money markets to maintain a cash rate consistent with its stance on the monetary policy
Open market operations conducted primarily by
- repurchase agreements (repos) on nominated debt securities
- outright or direct transactions in short-dated Commonwealth Government Securities
- foreign exchange swap.
The RBA holds and manages a portfolio of Commonwealth Government Securities to
maintain system liquidity and effect monetary policy.
- The RBA achieves this by purchasing CGSs in the secondary market and occasionally taking an allotment at tender in a primary issue.
Factors impacting on the liquidity of the financial system (or money base) are:
- Commonwealth Government budget deficits or surpluses
- official (RBA) FX transactions
- net sales of Commonwealth Government Securitie and repurchase agreements.
Factors impacting on the liquidity of the financial system (or money base) are:
(Commonwealth Government budget deficits or surpluses)
taxation receipts
government securities
budget recurrent expenditures
budget capital expenditures
Factors impacting on the liquidity of the financial system (or money base) are:
(official (RBA) FX transactions)
- sales of FX reduce financial system liquidity
- sales of FX by the RBA reduce system liquidity, which can be neutralised through market operations by buying CGSs
taxation receipts
Income tax, company tax, cgt, gst, gbt
Payments system
Facilitates the transfer of value of a financial instrument, used in transactions for goods and services, from one party to another
Payments system clearing systems
- Australian Paper Clearing System
- Bulk Electronic Clearing System
- Consumer Electronic Clearing System
- High Value Clearing System
- Australian Cash Distribution Exchange System
Australian Paper Clearing System
for cheques, payment orders and other paper-based payment instructions
Bulk Electronic Clearing System
for recurring electronic credit and debit payment instructions
Consumer Electronic Clearing System
for card-based ATM and EFTPOS transactions and ‘pay anyone’ via the internet
High Value Clearing System
for high-value payment instructions
Australian Cash Distribution Exchange System
for the movement of notes and coins.
Payments classified by RBA in two ways:
Low-value day-to-day payments for goods and services, particularly by the household sector.
High-value, large-value transactions for assets (e.g. property, wholesale market equity, debt securities and FX transactions) cleared by real-time gross settlements (RTGS).`
Exchange settlement accounts:
Same day funds held with the reserve bank; facilitates settlement of payments system value transactions
Real-time gross settlement (RTGS)
High value payments system, transactions are settled immediately through exchange settlement accounts
Repurchase Agreements (Repos)
sale of CGSs to the RBA on condition the seller will normally buy them back by day’s end
It provides intra-day liquidity for same-day funds for exchange settlement account holders.
RBA also provides end-of-day repurchase facility by offering overnight repos, but subject to interest being charged @ 25 basis points above the official cash rate (only for overnight repos). Incentive to use sparingly.
