The big picture on MGS

The Government of Malta last week announced a new issue of €100 million worth of government stocks split between two existing instruments, namely the three per cent MGS 2019, and 4.5 per cent MGS 2028.

The general environment for issuing government bonds is changing

It also reserved the right to increase the amount issued, should there be sufficient demand, by a further €70 million for a total of €170 million. Earlier this year the Government had indicated that it intends to issue up to €650 million of government stocks this year, primarily to redeem €370 million of different government stocks that mature this year and to finance the government deficit that is expected to be in the region of €164 million for the financial year 2013.

In the February stock issue the Government issued just shy of €200 million of government stock. Assuming that the current new issue raises the full €170 million, the Government would have raised almost 60 per cent of its requirement for 2013. This is in line with its stated policy whereby it announced that it will front end load the issuance of stocks in 2013. We expect that the remaining balance will be issued in two or three tranches between July and end November.

The demand for Malta Government Stocks has, over the years, remained extremely buoyant. This has provided a significant source of finance for the government to plan its budgetary requirements with the confidence that it will plug any gaps through the issue of such stocks. From an investors’ perspective, the lack of alternatives in finding an attractive level of income for a given risk has further enhanced the attractiveness of such stocks.

In many ways, they are treated like glorified deposits with retail investors buying into these bonds with the aim of holding to maturity, and in the meantime receiving the semi-annual coupon. To this end, they have served their purpose well and from an investment perspective, government bonds have been one of the better performers on the local market, especially when looking at them from a risk adjusted perspective.

The general environment for issuing government bonds is changing. On the one hand, the natural demand for such stocks should continue to support such issuance. After all, the list of alternatives is growing shorter by the day. Additionally, the economic outlook suggests that an accommodative stance by the ECB is likely to remain in place for many months (maybe years) given the trajectory on unemployment and economic growth throughout Europe.

On the other hand, these issues could make for a more challenging balancing of the books. We have seen the impact that austerity and lower government revenues have had on other countries and their ability to contain their deficit. It is critical that the local economy continues to grow to provide the government with sufficient elbow room to implement its policies. The next few years will provide a number of challenges. At the same time, the maturity profile of the government’s debt leaves little room for policy error.

As the chart shows, over the next five years more than 50 per cent (€2.33 billion) of the present government stock in issuance is due for redemption. There are two sides to this story. Firstly, there is the opportunity to rollover such debt while saving on interest payments. The average interest rate on the debt that matures over the next five years is 5.16 per cent whereas the average interest rate on the stock that the Government issued in February is a full percentage point lower.

The real challenge is not the interest rate but ensuring there is enough demand to roll over such debt. No matter that most of the debt is internal. If policy errors or the economic trajectory result in ballooning deficits, then investors will quickly shy away from government stocks, especially financial institutions which are the largest buyers of government stocks with over 38 per cent of the current stock.

When presenting the 2013 Budget, Finance Minister Edward Scicluna outlined the tasks ahead and pointed towards the need for fiscal prudence with a focus on sustainable public finances and strengthening fiscal stability as being major objectives. This approach is absolutely critical, not only to maintain the level of confidence that investors have in local government stock, but also to keep the EU at bay. We have seen the financial destruction that has been piled onto Cyprus and we ought to keep this lesson at the forefront of our minds, lest our instinct to be spendthrift gets the better of us. The consequences of such a failure would be unimaginable.

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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.

David Curmi is managing director of Curmi and Partners Ltd.