Government Commissioner for Public Debt Yuriy Butsa: We have some flexibility to not attract funding at any price
The first part of the Interfax-Ukraine interview with Government Commissioner for Public Debt Yuriy Butsa
Primary auctions on February 11 showed that rapid decline in rates in recent months and volatility in the global market have certain consequences: we see a decrease in the demand for long-term instruments from non-residents – it is lower than supply. How serious are fears that demand will decline to a level that will threaten the fulfillment of the borrowing plan this year? However, at the same time, the demand for short-term instruments has increased, and the Ministry of Finance manages to lower rates a little further on them.
What is your opinion of recent auctions?
Demand in the short end of the yield curve is driven by local investors. A natural alternative for them is NBU's certificates of deposit. Local players are refocusing from NBU's certificates of deposit to short-term domestic government loan bonds to capture yield, given the potential decrease in the interest rate that the National Bank is talking about. Therefore, since the beginning of the year, demand for each auction at this end of the curve is higher than the supply. This allows significantly lowering the rate.
The demand on the longer end of the curve is not so bad, which is confirmed by the fact that this year we have successfully released the 7Y instrument for the first time. But, in fact, the situation on the global market has changed slightly, and interest in investing in local currencies of emerging markets has decreased. It affects us.
Moreover, we are not alone on this market. Investors investing in Ukraine can also invest in Nigeria, Ghana, Turkey, Mexico, and other markets where the local securities market is developed. At some stage, at real yield rates, we are approaching other countries and investors will not only focus on yields, but also analyze other structural elements of the market, such as, for example, exchange rate policy transparency and the predictability and dynamics of inflation.
That is, in the current situation, do you see some margin of decline in the yield on the short end of the curve, while the situation on the long end has stabilized? Because at the auctions on February 11, for the first time in recent months, the average weighted yield of two-year domestic government bonds increased slightly - by 14 basis points (bp).
This is the usual situation. For investors in long-term instruments, there should be a long-term vision: first, inflation, and second, National Bank’s policy. As far as I understand this vision is already included in the cost. In the event of significant changes in market expectations, the cost may be on an upward or downward trajectory. If inflation accelerates, the cost of borrowings will objectively go up. If inflation drops significantly and the 3.2% (January annual inflation - IF) we saw will not be a temporary but a constant trend, then there will be more margin for lower rates as market expectations of inflation are at the level of 4-5%. Investors are looking at a real rate rather than a nominal one at auctions.
Is 10% the level above which the Ministry of Finance is not ready to pay?
This is not a question of being ready or not. We do not influence pricing on the market. The question is what volume we need. If larger volumes are needed, more price flexibility would be required. In the first month, we completed approximately one-sixth of the annual borrowing plan. Therefore, we have some flexibility not to attract funding at any price, to be more selective.
On February 11, the Ministry of Finance proposed a new issue of four-year domestic bonds, two weeks before that it offered seven-year domestic bonds. How many new issues will there be during the year? Will short issues continue to be offered?
The policy of the Ministry of Finance as to short-term instruments consists in a stable offer of the usual instruments for the market, in particular for the yield curve building. That is, instruments with maturity this year, one-year, two-year, three-year maturity - the way it was done before. Longer-term instruments are issued in particular for the purpose of their inclusion in indexes to ensure their higher liquidity. Accordingly, it makes sense to concentrate the demand on a small number of instruments in order to increase the volume of these instruments.
You see a 5-year instrument we issued six months ago with maturity term in 2024. We focused on it until we reached an estimated size of USD 1.4 billion, or about UAH 34 billion. This is a minimum enough level to be included in the indexes. What does it give us? It puts us on the global map; it means significant additional liquidity from the funds that passively track indexes. We are working hard to get the first instrument in the index. After that, it will be possible to issue new long-term instruments with a smaller volume - about USD 1 billion. We're talking about JP Morgan's GBI-EM index, the most popular one among investors in local markets. For example, Serbia or Egypt are also building a similar yield curve and concentrate on the long end of the curve on demand for several instruments to include them in the index. The index inclusion significantly broadens the range of investors and reduces the cost of borrowing.
What is holding back the inclusion of Ukrainian five-year instruments in this index? Because, to the best of our knowledge, the work has been going on since the fall of last year.
Work has been underway much longer: we started communicating with the index team back in 2017. Back then, of course, we did not have any foreign investors on the market, and we could not even dream of such development. In two years the situation has changed dramatically - Ukraine is one of the most dynamic local markets in the world. But there is a question of secondary liquidity, and it is not up to us. In order for liquidity to emerge in the market, someone has to start selling this instrument. And there are not those who want to sell it in such quantity that it indicates that there is significant liquidity. For an index team, such liquidity is very important; after all index funds must be able to buy the indexed instrument freely on the market.
I do not rule out the possibility that when the curve is flattened, the rates are flattened, subject to no significant margin for reduction, then some holders will finally be ready to sell. This will probably give secondary liquidity. But we do not control this process - it is happening on the secondary market.
Does it make sense to try to enter the index with shorter-term and more liquid instruments, for example, three-year instruments?
When the instrument is shortened, it is removed from the index. Therefore, we need a longer-term instrument to keep it longer in the index. And it is always necessary to add other longer-term instruments so that they could replace the previous ones, thus preserving the weight of the country in the index and building the yield curve further.
If Ukrainian domestic government bonds get into the GBI-EM index, what amount of additional demand can we expect?
It's probably not billions of dollars. Because now the index includes some instruments issued in China and carrying a lot of weight. Accordingly, the weight of all others decreases. Given that Ukraine is a small market compared to the Chinese market or other markets in the index, we cannot count on a large share with one instrument. According to the most optimistic estimates, we are talking about several hundred million dollars, not a billion.
Back to the latest auctions. At the end of last year, a schedule of borrowings for Q1 was published, and it lacked currency instruments. But on February 11, they showed up and demand was very high: 69 bids worth USD 280 million. And the market was ready to 3.5% rate. What is your decision associated with and why is the demand for these instruments at such rates so high in the domestic market?
Yes, domestic market rates have already come close to the external curve.
Concerning FX government bonds in general, we understand that in an ideal world, foreign currency instruments on the domestic market are a rudiment. Other developing countries are trying to develop a domestic curve in local currency and an external one in foreign currency. But, unfortunately, Ukrainian banks do not have access to liquid external Eurobonds because of the NBU regulation. Earlier this year, we did not add this instrument because we hoped the NBU would change this regulation. This is not happening yet, although the FX government bonds are evaluated by the regulator in the same way as external ones in terms of risk.
This NBU regulation has not entered into force, has it?
But it will be effective from March, so market players are already taking this into account. The National Bank's position is that Ukraine's currency commitments should be rated as other risk category "B" countries and not as a risk-free issuer for domestic investors. Therefore, domestic and external bonds do not differ in terms of risk. But Ukrainian banks still cannot invest in our external yield curve. Moreover, there is minimal demand for foreign currency loans, so there is a question of excess liquidity. It is now invested outside the country with a relatively low yield - in category "A" instruments. They are much less profitable than Ukrainian securities.
This year, we repaid domestic currency bonds in the amount of $ 570 million, with more than $ 2.2 billion left by the end of the year. In order to avoid the situation when the currency is invested outside the country instead of being invested in it, we have decided to continue the practice of domestic foreign currency auctions. To a limited extent. We will continue to limit the volume - for us, it is cheap liquidity, it is really short. We would like it to be in longer-term instruments. But there is no point in placing longer-term domestic foreign currency instruments. We place longer-term instruments on the foreign market. We would like the Ukrainian banks to have access to a more liquid instrument, since they cannot sell domestic government bonds at any time, unlike external ones. But as long as the regulation has not changed, we will offer short-term currency instruments at the market so that this liquidity remains in the system rather than going beyond the country.
At what stage are these negotiations with the National Bank?
These are negotiations held between the NBU and the banks. It is difficult for me to comment at what stage they are now.
As far as I understand, in a broad sense, we are talking about foreign currency deposits of citizens. The National Bank explains its actions by promoting de-dollarization.
Yes, people still save money in foreign currency, in deposits. Foreign currency deposit rates are low. But there is no dollarized country in the world where people have sold all their savings in dollars and converted them into the national currency. I see no change in this dynamic. Accordingly, banks will continue having this liquidity. Banks do not have enough borrowers for foreign currency loans. And high-quality corporate borrowers have the same possibility to fund outside the country. This situation of excess currency liquidity is likely to continue.
The January Eurobond placement rate, which we will talk about later, was 4.375%. If Ukrainian banks had access, could they form part of the demand for Ukrainian Eurobonds?
We do not discuss liquidity in euro at all. At the latest mid-December auctions, the rate on domestic government bonds denominated in the euro was 2.22%.
In Turkey or in other similar countries, much of the demand for external Eurobonds is generated domestically. And that's right. This makes it possible to reduce the cost of borrowing and to ensure productive allocation of the currency liquidity that is in the system.
Another interesting effect is that we are a country very volatile to external shocks. When something goes "wrong" globally in another country or when there is a global change in sentiment to developing countries, in such a situation the volatility of the Ukrainian curve is much higher than that of the Turkish curve. (We saw this in 2018: when Ukraine itself generated only positive news, its instruments quotations fell sharply because global sentiment itself was very bad for countries with a "B-" rating). Under these circumstances, foreign investors who do not see a significant difference between Ukraine and the African or Latin American countries start selling everything they have. And then the market is stabilized by local players who understand - this instrument has value: they start buying it keeping the curve. This adds stability at the external market.
This effect must also be taken into account. We would like this effect to take place on our market and we could have a local bid that will always maintain the curve and prevent it from moving due to changes in global sentiment that are not dependent on the economic situation in the country.
We have already seen two "black swans" on the foreign market this year: exacerbation of the Persian Gulf crisis and coronavirus. How would you evaluate their impact on Ukrainian instruments? How significant was it?
We are a small economy in the global world. We are highly dependent on global sentiment. If, because of global risks, investors make a decision to move to other assets - US Treasury bonds or gold - there is almost nothing we can do.
The January bond in the euro, which we placed not only at a record low rate, but also for the first time in Ukrainian history with a negative premium to the secondary market, would not have happened if we had held out for another couple of days. We entered the market on Wednesday, January 22, and by the following Monday we would have already issued it with higher coupon and a higher rate. The market started a sell-off that started from Asia and had a certain influence on our curve as well.
Therefore - yes, we are very dependent on the foreign market. The only factor we can influence in such a situation is a good macroeconomic history that allows us to stand out from other countries. If investors make the decision to leave emerging market instruments, they make the decision as to which one to leave first. Therefore, we will not be able to stop them from leaving, but what we can do is slowing the process down and ensuring that Ukraine will be the last market they will leave. This requires a normal macroeconomic policy – the continuation of fiscal and monetary policies we are implementing. And the most important factor influencing the price of our bonds is the prospect of cooperation with the IMF: correlation between statements or expectations regarding cooperation with the IMF and the level of quotations of our bonds is very clear.
You mentioned Egypt, other countries. Where is Ukraine currently on the global map of investors? Who are we competing with at the global market? A recent Deutsche Bank report said Egypt is already looking better than Ukraine, although Bank of America analysts still prefer Ukraine.
The reports you are talking about are relevant to the local market. Globally, our rating categories are Nigeria, Ghana, Egypt, Cameroon, and Belarus. Some of these countries have their own macroeconomic imbalances, they have terminated or completed IMF programs, and there is no clarity on future policies. So we look better in their background. But some countries have better natural resources, such as oil.
Therefore, again, we must have a stable, predictable economic policy. For example, we are significantly better than the countries in our category in terms of budget deficit. The low level of deficit and primary surplus gives investors a signal that refinancing needs will fall, the risk of an unstable market situation is lower for us - therefore we are a better investment. We should borrow less in the short term, we are less dependent on the constantly changing external environment.
Regarding the reports and comparing us to Egypt in the local market, in fact, Egypt is more attractive than we are in terms of rates. On the other hand, they have a 7% deficit, higher borrowing needs, higher concentration of short-term borrowings, and higher risk of refinancing.
We are trying to minimize the risk of refinancing and to extend the curve as far as possible, both external and domestic one. This will help us depend less on global sentiment. There is no country in our category that has dramatically reduced its debt to GDP. It is little appreciated within the country, but it is important for external investors. We are outstanding by far - we are almost the only country at our rating level that basically lowers debt to GDP, even more so at a fast pace. This means a lot more resilience than in the countries with which we are compared.
So maybe we are reducing the deficit too much and holding back economic growth, aren't we?
We have not yet reached the debt structure when we can somehow widen the deficit. We have a large percentage of foreign currency debt - about 60%. Any rate change significantly affects our debt. This is logical for any commercial borrower: if you get income in a certain currency, then you try to keep your debts in the same currency. We have budget revenues in UAH, but the hryvnia debt is a mere 40%.
We perform a risk analysis on a regular basis. The two biggest risks to public debt management that we see and are reflected in our strategy are currency risk and refinancing risk. Our priority is to reduce the debt component of the debt and to extend the borrowing period to reduce the refinancing rate each year.
Despite such a rapid decline in debt to GDP, there is still some distrust: Moody`s upgraded Ukraine's rating only half a notch last year, while Fitch and S&P moved Ukraine one notch up. Do you think that the rating agencies will be more optimistic about us this year?
We analyze the risks that credit rating agencies cover and prevent them from raising their ratings. In fact, we have completely decomposed the methodology of both S&P and Fitch and understand our weaknesses.
We can influence one of the important factors, but the other one is off limits for now. The first is a new IMF program: we already have a staff level agreement, but rating agencies will feel more comfortable once the program is approved by the Fund's Board of Directors.
The second factor that does not depend on us is the history of positive macroeconomics. Ukraine has a much longer history of wrong monetary and fiscal policy. Five years of sound economic policy is not enough for rating agencies to believe that it is long lasting: their methodology looks back up to ten years ago, and many countries confirm the need for such a long "probation" period. Unfortunately, we had many negative decisions in this area before 2014. And that still has a negative effect on our perception.
There are statistics that countries in our rating category have never jumped into the category "A". Do you believe that Ukraine can move to the bottom level in the investment category in the near future?
If we continue this fiscal and monetary policy, I believe that it will happen at some stage.