Monetary policy overlooks bond market

Monetary policy overlooks bond market

As the government is trying to deepen the country's bond market, secondary trading of the fixed-income tradable government securities jumped significantly in the last fiscal year (FY21). The value of annual secondary transactions of these securities stood at Tk 1377.70 billion in the past year, which was Tk 594.77 billion in FY20. The value of the secondary transaction was Tk 183.10 billion in FY19. The big jump in trading of these securities, a combination of treasury bills and bonds with different maturities, indicates that there is demand for bond or debt instruments.

Treasury bills are short-term government securities, while treasury bonds are long-term in nature.  These are all debt instruments for the government to mobilise funds from the financial market. Accordingly, players in the secondary market invest in these government-backed debt instruments to ensure safe returns. 

However, yields of these tradable fixed-income securities mostly declined in the last fiscal year indicating that demand for the securities is still not adequate or optimal. This is opposite to the global trend. The latest annual monetary policy statement (MPS) mentioned that the directions of long-term interest rates refer to the yield of government bonds maturing in 10 years, showing an increasing tendency in most of the major developed and developing countries, particularly after June 2020. "The main reason behind these upward trends of long-term interest rates was the high demand for government debt necessitated to execute the fiscal stimulus packages taken for recovering the Covid-19 related output losses," explained the annual MPS, released by Bangladesh Bank last week.

In Bangladesh, yields of 5-year, 10-year, 15-year and 20-year treasury bonds were above 8.0 per cent at the end of June 2020. The yields, however, came down to below 7.0 per cent at the end of June 2021. Central bank statistics showed that the yield of 5-year treasury bond came down to below 4.5 per cent while the yield of 10-year treasury bond stood at around 5.50 per cent at the end of FY21. The decline in yield reduces the rate of return for the investors. It, at the same time, eases some pressure on the government's interest payments liabilities.

A global virtual platform dedicated to analysing the government bonds across the world makes a forecast that the yield of all the Bangladesh government treasury bonds will decline further by the end of December this year. The underlying assumption is that there will be less demand, so investment in government securities may fall.

An increase in secondary transactions coupled with a decline in yields of the treasury bonds appears to be a puzzle. If secondary market transaction increases, it may be due to growing demand for the bonds. Again, if demand for treasury bonds increases, it should be reflected in the increase in yields. The common thing seems to be absent in Bangladesh, which means the market mechanism is not fully working here. The MPS sheds a little light on the issue.

The MPS mentioned that banks' surplus reserves maintained for the statutory purpose stood at Tk 2315 billion at the end of June 2021, Tk 1396 billion at the end of June 2020. Around 65 per cent of these surplus liquid asset reservesare kept by the banks in the form of government securities and so can easily be converted into cash in the interbank market or the secondary market.  The statement, however, acknowledges that 'the secondary market for the government securities is yet to be developed.' Thus the lack of an effective secondary market deters the more and long-term investment in the bonds. Instead, secondary transactions are mostly concentrated on short-term liquidity management. 

Sluggish economic activities due to Covid-19 drive the banks and financial institutions to invest and trade in the secured government debt instruments. In this process, the banks and financial institutions tried to offset a portion of losses of revenue earnings. In 2003, Bangladesh Bank introduced the Primary Dealer (PD) system in the country's financial market to bring efficiency in the government securities market. BB appointed a group of banks to deal exclusively with the treasury bills and bonds. Currently, PDs play a vital role in the primary market and provide essential liquidity in the secondary market as market makers. Non-PD banks and financial institutions, as well as individuals, can also participate in the market to invest in the government securities and transact in the secondary market.

Nevertheless, a secondary transaction in the bond market is still limited as the government securities entirely dominate the market. There is no secondary transaction of corporate bonds, and these are mostly traded among the selected institutional investors or banks and financial institutions. Thus, borrowers can mobilise their necessary funds, but the return on investment is confined to limited market players.  

The annual MPS also ignored the adequate diversification of the bond market. There is no mention or review of the latest bond market trend, including primary issuance of treasury bills and bonds, secondary trading of these instruments and yields.

When a monetary policy statement doesn't mention anything about the country's bond market or yields, it reflects the structural weakness of the country's financial market. It also indicates the central bank has little to do about containing the inflation through the money supply. Instead of providing some plain statements on the status of the bond market, MPS needs to go into detail and examine the relationship between yields and inflation. The central bank can't pursue an effective monetary policy by overlooking the development and diversification of the bond market.

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