Failed T bond auction - A failure of bond issuance system? Let us investigate

According to media reports, the central bank (CB) has rejected all bids received at the T bond auction held on 30 October. Therefore, this short article is to raise concerns whether the rejection of all bids is a new sign of the failure of present T bond issuance system.

Present T bond issuance system

Present system was introduced in the middle of 2017 by discontinuing the full auction system followed since the beginning of March 2015. Accordingly, the new the system is a so-called hybrid system containing the auction window and post-auction placement window as follows.

• Auction window - competitive bids received in the electronic auction system where accepted bids carry multi-prices/yields on each fixed coupon bond offered to the auction.

• Post-auction non-competitive placement window - Bids are received through e-mail from primary dealers whereas the auction weighted average yield is offered for all bids accepted manually on each bond announced for placements immediately after the release of auction results. As there is settlement time of few days, dealers have the time to find money.

This system was launched as a strategy to ensure that total funding requirement at each auction is raised with the support of contingency funding from the placement window while reducing the pressure on yields. However, funds have been raised in excess of the auctioned amount from some auctions.

The system prior to March 2015 was a non-transparent, 80%-90% private placement-dominant-system used by the CB to drive its monetary policy on market interest rates through debt management instruments without any regard to market-based debt management principles. In fact, top monetary policy experts of the CB testified at public investigations that such a heavy-weight bond placement system was used to control interest rates in the economy. Accordingly, the Monetary Board in its Annual Report 2016 attributed the rise in interest rates to the pure auction system as highlighted below without any economic research, despite the fact that the Monetary Board itself raised policy interest rates by 1% in 2016 and by 0.25% in March 2017 and SRR by 1.5% in January 2016 and underlying market forces. 

• The impact of replacing the mixed system of auctions and direct placements to raise funds for the government with a purely auction based system where direct placements of Treasury bills were made only with the Central Bank, also contributed to the increase in interest rates on government securities.

• Speculative increases in yield rates within the purely auction based system in issuing government securities may also have impacted the monetary policy transmission to some extent.

However, no action is reported to have been taken so far in respect of significant irregularities found in the placement system as recommended by public investigations. Instead, same authorities have been reverting back to the flawed issuance system under the cover of prudent debt management with lowest cost and risk. The fact of the matter is that debt has now been both unsustainable and defaulted as proclaimed by same authorities.

Results of last T bond auction held on 30 October 2023

Auction results published by the CB for the last auction are as follows.

The CB does not reveal reasons for rejection of all bids received at the auction or bid details. However, the general understanding for the rejection is all bid yields being higher than the market yields believed by the CB as being fair in its opinion. As stated in the Tender Board mandates, this opinion is largely influenced by the monetary policy requirements on controlling market interest rates. Therefore, only the God knows the CB's view of fair market yield rates.

Why all bids would have been rejected?

• Two bonds offered were reissuances of existing bonds to raise new funds as there were no bonds maturing on the settlement date 01 November 2023. If this had been an auction for rollover of maturing bonds, bid yields would not have risen so high because investors would rollover maturing proceeds without involving in additional costs. 

• For example, T bond auction held on 25 September was successful as it was a rollover in respect of bonds matured with a face value around Rs. 223.2 bn plus coupon on 01 October. Therefore, the CB could raise Rs. 220 bn from the auction and Rs. 16.7 bn from the placement window at the weighted average yield around 15%.

• The two bonds offered at the last auction are medium-term bonds that are subject concern over debt unsustainability as proclaimed by the CB. Further, bond restructuring policy itself raises concerns over a possible default, given the current fiscal outlook. The CB also conducted a similar auction for new funds on 12 October and raised Rs. 25.5 bn (25 bn auction and Rs. 2.5 bn placements) at yield rates around 15.2% and 13.6% as shown in the Table below. Therefore, investors may not have been willing to provide new funds at further lowering interest yield rates as expected by the CB at the last auction. However, the demand was significantly higher than the offered amounts.

• Another T bond maturity of face value Rs. 180.6 bn is due on 15 this month. The bid yields, if accepted at the last auctions, would have a significant influence in the next auction yields due in two weeks for the above bond repayment. The average yield quotes of primary dealers for the purchase of same two bonds offered at the last auction were 14.10% and 13.46%, respectively, in the secondary market 27 October (business day prior to the auction date) as reported by the CB. However, bid yields at the last auction would have been much higher than the secondary market yields. Therefore, the CB would have rejected all bids at the auction with the intension to prevent the yield rate pressures at the next T bond auction for rollover of a huge sum as the Treasury seemingly does not have funds to repay the maturing bond.

• The CB is now following a lower interest rate policy as seen from policy interest rates and T bill weekly auctions conducted by the CB (see the Chart below). Therefore, the CB may have had a highly arbitrary/bureaucratic bias towards lower yields through auctions of government securities, instead of the standard conduct of its open market operations through printing of money to control market interest rates. Therefore, this total bid rejection is tantamount to the conventional attempt of the CB to conduct the monetary policy through fiscal instruments.

Concluding Remarks

• As highlighted above, it is clear that the CB has rejected all bids at the last auction to prevent the rise in market yields and interest rates in the foreseeable future.

• However, what ever reasons are behind the auction decision, the rejection of all bids is evidence for the failure of the present hybrid fund raising system, i.e. auction window plus contingency funding/placement window. The contingency window could not open as it was linked to auction weighted average yield rates on offered bonds. Therefore, placement window was not really a contingency funding window to support the government, but an insider scam to support the dealers to secure a bidding risk-free subscription at an artificially higher yield, i.e. auction weighted average yield, where dealers have the insider ability to fix the weighted average yield in their favour. As such, the failed auction is a result of the flawed design of the bond issuance system.

• Despite the so-called hybrid system implemented by the CB as a major instrument of the public debt management since the middle of 2017, the government now confronts unsustainability in both T bonds and public debt stocks as proclaimed by the CB in association with the IMF, the economic guru of the CB and Government. As a result, debt restructuring is in a painful process to prevent a major default.

• However, such bureaucratic modes of auction bid rejection show chronic liquidity conditions in the government securities and credit markets in the near future that might even trigger systemic risks given the inter-connectedness between the fiscal front and the rest of the economy through the monetary and financial system.

• Therefore, it is the public responsibility of the government to ensure that the government securities market operate through transparent and fair forces independently from the monetary policy priorities, given the present bankruptcy of the fiscal front and its adverse impact on the general public as witnessed by the present economic crisis as well as the monetary policy autonomy assured by the brand new CB legislation certified on 14 September 2023. Otherwise, debt restructuring and IMF debt targets will only be another bureaucratic actions without the support of debt market principles and discipline. 

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 12 Economics and Banking Books and a large number of articles published. 

The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)