Short-term, high-interest T-bills make no economic sense now

Greece is supposed to have one of the highest public debt-to-GDP ratios in the eurozone and suffer from one of the highest inflation rates, undermining the international competitiveness of its economy. Yet, the Greek Finance Ministry reportedly wants to issue three-, six- and perhaps nine- and 12-month inflation-linked T-bills, paying 0.4 to 1.0 percentage point over inflation, in a bid to satisfy the demand for positive real returns among both investors and depositors. This may well turn out to be a good «political weapon» for the government but does not amount to good economics for a high-debt country with inflation. Finance Minister Nikos Christodoulakis is reportedly ready to announce the issuance of 5 billion euros’ worth of T-bills, in denominations of up to 8,800 which pay up to 1.0 point over the inflation rate, succumbing to pressure by an investment public longing for nominal returns in excess of inflation. This public, accustomed to double-digit or at least high single-digit returns from bank deposits and T-bills, has been puzzled and angry to learn that it will receive less than 3.25 percent from repos and time deposits at a time that national consumer price inflation is estimated to average 3.5 percent or more next year. This same public has not been very receptive to a series of initial capital-guarantee products linked to the return of stock indices, commodities and currency pairs that are offered by local banks. The Finance Ministry knows, of course, that inflation-linked instruments of such short duration will just increase the burden of servicing the country’s huge public debt, but it seems determined. This is partly due to the fact that general elections, scheduled for the spring of 2004, may take place in 2003 and partly because it wants to put more pressure on local banks to offer new products offering higher yields. One must remember Greek public finances were restated in 2002 at Eurostat’s demand that proceeds from securitization, convertible bonds and privatization certificates (prometoha) be included in the calculation of the general government’s public debt. Following the revision, the country’s public debt-to-GDP ratio shot up to 107 percent for 2001 from an earlier 102.7 percent, and is estimated to have fallen to 105.3 percent last year. The 2002 public debt-to-GDP ratio was projected at 99.6 percent prior to Eurostat’s revision. The government wants to reduce the same debt ratio to 100.2 percent this year. According to BNP Paribas, Greece is projected to issue 27 billion euros’ worth of government bonds in 2003, representing a small increase in gross supply versus 2002 but a decline in net supply, that is, gross supply minus redemptions. Some 12 billion euros will be borrowed in the first quarter, 6 billion in the second quarter, 5 billion in the third quarter and 4 billion in the last quarter of 2003. The economists at the French bank claim this combination of a slight rise in gross supply and a decrease in net supply puts Greece in the same grouping in 2003, along with Germany and Spain. Belgium, Portugal and Ireland form the first group of EMU countries where gross as well as net supply of government paper will be actually lower than in 2002. It is as yet unknown whether the new issue of Greek inflation-linked T-bills will add to the country’s 2003 borrowing or simply replace some other issues. Undoubtedly, the inflation-linked bonds will increase the 2003 budget’s interest expenses, since the country can pay much less in interest to borrow the same amount in the same maturities. The annual yield of the 12-month T-bill auctioned last November was about 2.69 percent. Even if the government opts for a real interest rate of 0.4 percent, it will be forced to pay a nominal rate of about 3.9 percent to the inflation-linked 12-month T-bill holder, assuming an inflation rate of 3.5 percent. Even if inflation drops to 3 percent year-on-year in January, it will have to pay 3.4 percent to inflation-linked T-bill holders, which is much higher than comparable debt instruments of the same maturity. Therefore, it does not make sense from an economic point of view for a country plagued by high debt and high inflation to issue such instruments with short duration. Local commercial banks, feeling the heat from the Finance Ministry’s move, are complaining. To some extent, they are right to complain. After all, some of them belong to the primary dealers group that is responsible for taking up Greek government bonds at scheduled auctions. On the other hand, banks are now dealing with this unpleasant situation because they have been unable to satisfy the natural demand for higher-yield deposit products at a time of low market rates. This is partly due to lack of know-how and partly to their own inflated cost base which forces them to command unusually high yield spreads. It is no coincidence that banks offer customers a pretax return of about 2.55 percent for a 14-day repo at the same time they earn 5 percent or more from the government bond used in the transaction. Still, the Finance Ministry could have done something simpler to address the problem and fend off charges of unfair competition by banks. It could have issued long-term inflation-linked bonds that offer a higher real return in the order of 2 to 3 percent much like the USA’s TIPS (US Treasury Inflation-Protected Securities) or Canada’s RRBs. Investors would receive an annual coupon payment on their principal which would have increased by the change in inflation over the same period. The government would then have been able to satisfy the demand for positive real returns from individuals and simultaneously extend their investment horizon, provide an instrument to others, such as insurance companies, to match their future liabilities and finally diversify its own portfolio with new 5-, 7-, 10- and 20-year instruments. Moreover, if these long-duration instruments were to be traded, this could also be a useful gauge of future inflationary expectations as it is in other countries. The Finance Ministry’s obvious decision to offer short-duration instruments that provide protection against inflation is unfortunate. It increases the budget’s interest expenses and causes friction with local banks. It may, however, win with the public which is hungry for high yield instruments and from that point of view may prove valuable as the date approaches for general elections. However, the ministry could have done much better on the economic front had it issued long-duration rather than short-duration inflation-linked bonds.