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Economics Legislation Committee
17/10/2012
Estimates
TREASURY PORTFOLIO
Australian Office of Financial Management

Australian Office of Financial Management

[20:36]

CHAIR: Welcome. Mr Bath, do you have an opening statement?

Mr Bath : No, Senator.

CHAIR: Earlier this month, why did your office sell notes over a 16½-year term—the longest maturity bonds on record? Could you outline your thinking about that long period of time?

Mr Bath : Yes. They are actually not the longest maturity bonds on record; they are the longest nominal bonds on record. Nominal bonds are bonds that are not indexed to inflation. We have historically issued longer bonds that are indexed to inflation. There is some demand among superfunds for longer dated inflation linked bonds and we have issued them from time to time in the past. Currently, our longest bond is an inflation linked bond, with a maturity of 2030. The maturity of the bond that we issued last week is April 2029. Following the budget in May, we announced that we had the intention of opening up a new 2029 line. The agency has announced that we have been planning to extend the length of the yield curve. I think we announced that at the beginning of the previous financial year, and we extended the yield curve to 15 years from a previous average of around 12 to 13 years.

Essentially, from a debt manager's point of view, longer dated nominal debt is better in the sense that it provides certainty of cost outcomes for longer. It is a little bit like fixing your mortgage for 10 years rather than five. You do it, except that sometimes it comes at a cost. Historically, it is our job—it is the essence of our job here—to balance the cost with the savings in risk. All else being equal, we would like to issue longer bonds, but it comes at a cost and that cost is borne out by investors typically requiring a higher yield for longer dated bonds, for locking their money up for a longer period of time. From their perspective, longer dated investments of a fixed rate nature are riskier because they are looking at it from the point of view of a market to market perspective and that adds volatility. The longer the bond the more volatility and they want to be rewarded for that risk. So, typically, they demand a higher yield for those and we have to balance that.

However, at the moment, we have been benefiting, over the last couple of years in particular, from the opposite of a term premium, if you like. Australian dollars have become a reserve currency to a degree and, as a result of that, we have been able to issue longer without paying a higher premium. That said, our yields are a little bit higher for a 2029 bond than they are for a 2027 bond, but the outright yield was under 3.6 per cent per annum. So we were able to lock in funding at 3.6 per cent per annum for 17 years—not that we are terribly opportunistic about these things, but we have been signalling to the market for some time that we have been planning to extend the yield curve and increase the average duration and average term to maturity of our portfolio as a whole.

CHAIR: How frequently, then, does your office sell notes over any given calendar year?

Mr Bath : Typically, we will issue Treasury notes, which are a short-term instrument out to three months, once a week on Thursdays. We will issue our bonds, which now have maturities of up to 16½ years, twice a week on Wednesdays and Fridays. But when we open up a new individual bond line, as we did last week, that will typically only happen once or maybe twice in a year.

CHAIR: How does your decision making process around bond issuing work? How do you decide whether the debt term should be three years, eight years, 10 years or, in this case, 16½ years? Do you like to have a pass of all the bonds that are maturing over a long period? Do you just make do with the equation?

Mr Bath : We want to spread it out so that we do not have too much of what we call 'refinancing risk'—that is, too much debt maturing on a single day. That is one consideration. Our primary consideration is to smooth the variability of debt servicing costs through time but, as I said earlier, that usually comes with a trade-off in that the smoother we make it by issuing really long-dated bonds the more it costs. This is the trade-off we have to make.

CHAIR: What is the trade-off?

Mr Bath : The trade-off is cost and risk.

CHAIR: As always.

Mr Bath : Shorter-dated bonds tend to have lower interest rates in the very long run, but they give rise to very volatile interest debt servicing cost outcomes.

CHAIR: Is the debt maturity cycle a critical factor in your process of thinking?

Mr Bath : Yes. Existing debt goes into the mix. We would not continue to build an individual bond line up beyond a certain amount. Our largest bond line probably has about $16 billion or $17 billion on issue at the moment. It is unlikely that, with around $250 billion on issue, we would grow an individual bond line much beyond $20 billion.

CHAIR: It would be too concentrated otherwise.

Mr Bath : That is right. As it matures, we would have $20 billion of refinancing to manage, which means we would be building up a lot of cash in advance.

CHAIR: How much lead time does your investment committee need to execute the sale of Australian government bonds?

Mr Bath : We do not have an investment committee, but we do have an asset liability committee. Essentially, if you are talking about a new bond, that is something my team in financial risk will be doing research on constantly. For example, when we made the case to extend the yield curve to 15 years we had been doing research on that for probably a good year to make that trade-off between extending the yield curve and increasing duration versus—

CHAIR: Do you do all that research in-house?

Mr Bath : Yes.

CHAIR: You do not contract it out to any of the investment banks?

Mr Bath : No, not anymore.

CHAIR: Is that for security reasons or because you are more competent?

Mr Bath : We will let others be the judge of whether we are more competent or not. In years gone by we had contracted out to investment banks the setting of benchmarks et cetera. One of the reasons the AOFM was set up was to enable people to specialise in debt management within the Treasury portfolio and to be able to recruit and retain expertise in financial risk management and Treasury management. You would expect that if you were going to set up a specialised agency—

CHAIR: You would rely upon it.

Mr Bath : you would want them to produce the sort of research that we are producing.

CHAIR: When you are doing that in-house research about the funding needs of the Australian government on a future basis going forward, do you do the work exclusively within your organisation and then advise Treasury of your thinking and your recommendations, or do you consult with them in that 12-month research process?

Mr Bath : It is more like the latter than the former. We have an advisory board which is chaired by the Secretary to the Treasury and it has representation from within government. The head of the budget group in Finance and the head of Fiscal Group in Treasury are also members of the advisory board and we have external members. Essentially, our process would be to get our research into a robust shape internally and then test it with our advisory board, seek guidance and refine it accordingly.

CHAIR: And having done that process then consult with Treasury and the like?

Mr Bath : That process is in effect consulting with Treasury, because the advisory board is chaired by the Secretary to the Treasury and it has representation from the head of Fiscal Group and, typically, senior members of budget policy division will attend as observers. Perhaps in the immediate lead-up to an advisory board, where we are bringing some research, we might share our paper with budget policy division and we will have some engagement with them and go through the technical points.

CHAIR: As we increasingly appear to have inflation in the areas where the government has decided it wants it to be and institutions are giving effect to that policy and it appears to be reducing significantly over time, is the preference of your organisation going forward for longer dated debt maturities?

Mr Bath : Yes. I think I have already answered that, all else being equal, we would prefer to issue longer dated debt rather than not. But there is a trade-off involved. Our assessment is that the cost of the insurance, if you like, that comes from issuing longer dated debt is particularly low at the moment because Australia is acquiring a safe haven status and it is one of the few triple-A rated sovereigns at the moment. There are not terribly many who are triple-A rated by all three agencies with a stable rating and there are even fewer of those that have more than $200 billion on issue, which gives investors comfort that there is some liquidity in the bond market.

CHAIR: Thank you for those details, Mr Bath.

Senator CORMANN: Not wanting to dwell on it, but I just want to note that we are disappointed that we were not advised until we made inquiries today that the CEO of the AOFM was not appearing today even though he has known for a year that he was going to be overseas today.

Mr Bath : I think we advised through normal channels about a month ago. He is at the OECD, Senator.

Senator BUSHBY: We received notice this morning.

Senator CORMANN: Anyway, I do not want to waste time.

Mr Bath : As I said, Senator, I think we advised through normal channels on 21 September.

Senator CORMANN: Thank you. Can we just confirm the value of government gross debt right now?

Mr Bath : Yes. As at today, there is $257.136 billion on issue.

Senator CORMANN: When is the face value of Commonwealth government securities expected to peak?

Senator Wong: The gross debt percentage of GDP I think in the FBO was 18.4 per cent in 2011-12.

Senator CORMANN: Sorry, when is the face value of Commonwealth government securities expected to peak?

Mr Bath : As we answered a question on notice from Senator Bushby after the last round, we said that it would be around $280 billion in April 2015.

Senator CORMANN: So that is still current, is it?

Mr Bath : There has been no update since the budget, Senator.

Senator CORMANN: So that is your current expectation. What is the face value of Commonwealth government securities on issue every year until net debt is forecast to reach zero in 2020-21? Have you got a figure for each year?

Mr Bath : Yes. We provided that on notice to Senator Joyce, I believe. Do you want it subject to the CIS cap, which is what we provided, I believe?

Senator CORMANN: If you could give us a peak amount in dollars.

Mr Bath : Peak or at 30 June numbers each year?

Senator CORMANN: The 30 June numbers and peak.

Mr Bath : They have not changed since we answered the question on notice. For the record, they are $239 billion as at 30 June. These numbers are excluding the $4.6 billion that is not subject to the Commonwealth Inscribed Stock Act cap. So for 30 June 2013, $239 billion; for 30 June 2014, $246.4 billion; for 30 June 2015, $247.1 billion; and for 30 June 2016, $249.7 billion. As we said in our answer to the question on notice, we do not have a number beyond the forward estimates period. You can add to get the total amount on issue, you can add $4.6 billion that is not subject to the CIS Act for the first three years—2013, 2014 and 2015—and that falls to $2.5 billion as at 30 June 2016.

Senator CORMANN: So why does gross government debt on issue continue to increase, if the government is forecasting a surplus for each year over the forward estimates?

Mr Bath : Not every dollar that is required for financing is fungible, if you like, with a dollar from the budget—in other words, you can be running a surplus as is forecast for the current financial year but still have a net financing task. So we will be issuing $35 billion of nominal bonds in the current financial year as our current plan, of which $26 billion is to cover maturities—maturing nominal bonds—implying a financing task of $9 billion plus there is another $2 billion of inflation linked bonds. There is an $11-billion financing task in a year where you have got a budget surplus, and so things such as infrastructure investment that are below the line still require financing and that is the answer to your question.

Senator CORMANN: So what you are saying is: because the government has to continue to borrow for items that are off budget—when you say below the line, can you talk us through what you are talking about there?

Mr Bath : There are different budget measures, so you can be talking about underline or headline budget balance. The number that matters to the AOFM is the financing task.

Senator CORMANN: So that is the headline cash balance still requires funding over the forward estimates?

Senator Wong: The financing task.

Mr Bath : The financing task and the budget balance will not necessarily be the same thing.

Senator CORMANN: Might not necessarily be the same thing—

Senator Wong: This is two as well—some of this you might want to cover tomorrow in Fiscal Group, Senator, because, obviously, Mr Bath can talk about the financing task. That is what they do, and they do it very well. They have very good rates at the moment for the public, but I think here we have got a number of dynamics operating. One is a stock and flow issue in terms of debt; and the second is, obviously, there are investments the government has been upfront about in infrastructure. I suggest some of these questions would be better addressed to Fiscal Group.

Senator CORMANN: So, Mr Bath, when you talked about items to be funded below the line, were you talking about the NBN, the Clean Energy Finance Corporation—

Mr Bath : NBN would be an example but, as the minister said, these are questions best answered tomorrow by Fiscal Group. Essentially, our task starts the financing task. They tell us what money they need. They can also tell you how they account for it.

Senator CORMANN: The RBA cut its cash rate by a quarter point on Tuesday, 2 October and the accompanying statement about the economic outlook referred to a fall in key commodity prices in our terms of trade since the forecasted budget. As a result of this change in economic conditions, what will be the impact on the government's projected peak in growth debt both in terms of height and timing?

Mr Bath : You are asking me what is the financing task, and these are questions for Fiscal Group.

Senator CORMANN: If you look at the final budget outcome for 2011-12 on page 38, note 10 to the Australian government financial statements in part 2, there is a table there entitled 'Interest expense'? You are familiar with that?

Mr Bath : I do not have it in front of me, Senator, but one of my colleagues Mr Johnson, who is head of reporting, is digging it up, I believe.

Mr Johnson : Was that note 10, Senator?

Senator CORMANN: Yes. The tables show a $471 million overshoot in the Commonwealth's total interest expense for 2011-12 between the actual outcome to 30 June and the forecast published in the budget less than two months earlier. This was driven by a $566-million or 39 per cent blow-out in the category of 'other financing costs'—that is from a projected $1,440 million to an actual $2,006 million.

Mr Johnson : Sorry, was that note 10 or table 10?

Senator CORMANN: Note 10, 'Interest expense'. It is from page 38 of the final budget outcome.

Mr Johnson : Okay, you were referring to other figures. The government securities line was the number you were focused on—

Senator CORMANN: If you look at the other financing costs in note 10, you have a figure there, an estimate, at the 2012-13 budget of $1,440 million and a final budget outcome two months later of $2,006 million. What is the reason for that difference?

Mr Johnson : To be honest, I am not sure about the other financing costs there.

Mr Bath : That is the part of the financing task that we do not manage, I believe.

Senator Wong: I am sure AOFM could tell you about government securities. I will see if we can address this question tomorrow.

Mr Johnson : I think it would probably be Fiscal Group.

Senator CORMANN: It seems to be a significant blow-out, nearly 40 per cent from an estimate.

Senator Wong: We actually issued less debt in 2011-12 than was expected at budget. The Treasurer and I made that clear when we announced FBO. We can talk about the market value issue and how that is reflected in the figures, and I am sure Mr Bath or Fiscal Group can explain that in more detail. In terms of this, as I understand it, AOFM can answer questions about the PDI impact.

Mr Bath : We could explain why the cost has fallen on government securities, but—

Senator Wong: In terms of the other financing costs, I am sure you will remember to raise it tomorrow.

Senator CORMANN: Explain that bit to us and then we will check the other bit with Fiscal tomorrow.

Mr Bath : The short answer is we issued less debt and interest rates fell. I think Mr Johnson might be able to add more to that.

Mr Johnson : You have stolen my thunder, yes!

Senator Wong: Feel free to explain that.

Mr Johnson : It is a combination of the two effects, yes. There was less debt and we had lower interest rates for the last few months of the year compared with what we assumed at budget time.

Senator CORMANN: Obviously I will pursue this further tomorrow. I had a discussion yesterday with the secretary of the department of finance about Aussie Infrastructure Bonds. Is there a separate class of government securities, being Aussie Infrastructure Bonds, with unique features that specifically target retail? I see you shake your head.

Mr Bath : No is the answer. They are fungible to the market. The market does not know whether they are buying an infrastructure bond or not. They are essentially—

Senator CORMANN: So it is just a marketing ploy?

Mr Bath : No, it is a means of tracking the financing for infrastructure items.

Senator CORMANN: So it is a marketing ploy.

Mr Bath : I think I have answered your question.

Senator Wong: Senator, do not verbal people. If you want to make a political point—

Senator CORMANN: What is the reason for it, if they are exactly the same—

Senator Wong: That is a policy decision which Treasury can answer. Mr Bath is saying from a financing perspective that these bonds are fungible. So from the market's perspective—

Senator CORMANN: So they are exactly the same with the exact same features?

Mr Bath : Yes. You cannot tell if you are a bond holder whether you own an infrastructure bond or not, and I cannot tell you because I do not know. It is done within Treasury.

Senator CORMANN: I am not meaning to be flippant. It goes to branding in terms of attracting a particular cohort of—

Mr Bath : I am not an expert in marketing, but I would not describe it that way.

Senator CORMANN: What is the purpose of it if they are exactly the same?

Mr Bath : That is a question for Treasury.

Senator CAMERON: Mr Bath, the AOFM is described as the specialist Australian government agency responsible for management of Australian government debt. Is that accurate?

Mr Bath : That is fair. There is only one of us, so I guess we are pretty specialised.

Senator CAMERON: That is what you say on your website, so it should be fair!

Senator Wong: The website must be right!

Senator CAMERON: Your website says the AOFM also manages the governments cash balances and invests in financial assets. We have heard questions tonight about the $257.163 billion debt. Is that correct?

Mr Bath : It is $257.136 billion, face value as of today.

Senator CAMERON: If this were such a huge problem as the opposition are making out, why would we be considered a safe haven and why would we have a triple-A rating if we were about to default on debt or not be able to pay the interest on the debt?

Senator Wong: Perhaps Mr Bath can answer the question without reference to the opposition.

Senator CAMERON: Okay. Some commentators are indicating that we may not be able to pay not only our debt but the interest on our debt. Do you have any views on that

Mr Bath : Perhaps I could answer it this way: as I said earlier, Australia is becoming more and more of a safe haven. If you look at the breakdown of reserve currencies held by reserve managers across the world, the Euro, the yen, the US dollar and the sterling are still the biggest share, but there is this other component, where 'other' includes Australia and also Canada, and that other component has been growing quite steadily since the global financial crisis. So I am not sure that anyone would reach the conclusion that we are on the verge of defaulting.

Senator CAMERON: Do you mean no-one in reputable financial—

Mr Bath : I will not use the word 'reputable', but no-one whose job it is to invest in sovereign debt, I think, would make the case that we are on the verge of default.

Senator CAMERON: You have absolutely no doubt that the debt position of the government is eminently sustainable in terms of being able to pay the interest?

Mr Bath : I have no doubt whatsoever.

Senator CAMERON: No doubt whatsoever?

Mr Bath : That is correct.

Senator CAMERON: So, if commentators are out there arguing that we cannot even pay the interest on our debt, that is not correct?

Mr Bath : I would struggle to see how it would be correct.

Senator CAMERON: Australia has carried significant debt in the past, hasn't it?

Mr Bath : Yes. Maybe you could be more specific about what you mean by 'significant'.

Senator CAMERON: After the Second World War.

Mr Bath : After the Second World War we had quite an amount of debt. I could not tell you off the top of my head what it was in terms of per cent of GDP, but our internal historian, Mr Johnson, happens to be with us.

Mr Johnson : I understand it was over 100 per cent of GDP.

Senator CAMERON: One hundred per cent of GDP after the Second World War?

Mr Johnson : Just over, I believe so.

Senator CAMERON: I have seen some Treasury papers that indicate that debt was paid off very quickly following World War II. I see analysis by Paul Krugman and Joseph Stiglitz saying that, if there is some margin of inflation, that minimises the cost of debt to government and it diminishes over time. That has been the history of government debt over many, many decades, hasn't it?

Mr Johnson : I believe often it is a combination of economic growth, and some inflation will help deflate those debt to GDP ratios, and fiscal consolidation may have played a role as well.

Senator CAMERON: All of these historic economic factors would lead any analyst of any credibility to say that Australia's debt situation is sustainable.

Mr Bath : Some research has come out in recent years by Carmen Reinhart and Kenneth Rogoff. They have done a lot of work on this. They have put out a book called This Time is Different. The title is meant to be ironic. The number that they have put into the public domain that is often quoted as being quite a serious number in terms of debt to GDP is 90 per cent.

Senator CAMERON: What is our debt to GDP ratio at the moment?

Mr Bath : I think we are estimating gross debt to GDP to peak at 18 per cent and it is below that at the moment.

Senator Wong: Eighteen point four, gross debt.

Senator CAMERON: And net debt, which I think is the more useful figure?

Senator Wong: Ten per cent in 2011-12.

Senator CAMERON: Isn't net debt the more useful figure that is what governments use?

Mr Bath : It is more useful for cross-country comparisons. Gross debt, if you like, is relevant for investors because they want a liquid bond market. If investors had their say we would be issuing more debt, rather than less.

Senator BUSHBY: First of all, Mr Bath, I wonder whether you have the chart that you normally produce.

Mr Bath : I do have a chart for you.

Senator BUSHBY: That would be appreciated. Secondly—

Mr Bath : Sorry, I have two charts. The first one is becoming a little bit—

Senator BUSHBY: Messy and hard to read?

Mr Bath : The yield curve is relatively flat, as I said early, so the lines are so close together you cannot discern the fact that not all of the short bonds are now at the bottom of the chart and all the long bonds are at the long end of the chart. I have got another chart, which is the yield curve currently and for around the last time we met, at the end of May. I am happy to table both of those.

Senator BUSHBY: Thank you. That would be appreciated. Going back to a question that Senator Cormann asked—

Mr Bath : Sorry, do I need to keep a copy of one of these? Are you going to ask me questions?

Senator BUSHBY: I will not have time to do that. In terms of the $9 billion new financing requirement that you referred to earlier, I understand that the AOFM is not responsible for detailing why that finance is required. Can you detail how this figure has varied between financial years? That is, going back to 2009-10, what was the forecast for the 2012-13 financial requirement, and again in 2010-11 and again in 2011-12? How has that changed over the forecasts?

Mr Bath : For the 2011-12 year?

Senator BUSHBY: For the 2012-13 year.

Mr Bath : I do not know that I have each year's projection for financing tasks in front of me. I think I would have to take that on notice.

Senator BUSHBY: No indication?

Mr Bath : For the 2012-13 financial year, I do not think we have the planned financing task all the way back to 2009-10.

Senator BUSHBY: Do you have that information for the 2011-12 year, looking back to the forecast for that year?

Mr Bath : We might. I do not know if we have it on us at the moment.

Senator Wong: Just take it on notice.

Mr Bath : I think we will have to take it on notice.

Senator BUSHBY: Please also take on notice the two years before that as well: 2012-13, 2011-12 and the two years before that.

Mr Bath : Yes, but are we talking about—

Senator BUSHBY: What I want to see is the trend of how the forecasts actually then move into the actual.

Mr Bath : For the actuals, do you just want the 2012-13 year, or do you want the 2011-12 an 2012-13?

Senator BUSHBY: No, the actuals and then the forecast period for the three or four years beforehand as well.

Mr Bath : I understand, but which actual years do you need?

Senator BUSHBY: All the years, including 2012-13 if you can do it. You said you were not sure, but at least 2011-12, 2010-11, 2009-10 and 2008-09.

Mr Bath : I think that we can probably dig something up for you.

Senator BUSHBY: Thank you.

CHAIR: I thank the officers from the Australian Office of Financial Management. Thank you for your assistance this evening.