After enjoying a winter of relative plenty, the government once again reached the bottom of the purse in May and was forced to accept almost 30% yields on state bonds. Citing costly infrastructure projects and the almost 90 billion Sk ($2.7 billion) in old loans that it must repay this year, the Finance Ministry claims it has had no choice but to accept the exorbitant interest rates.
Capital market analysts agree, adding that commercial banks' profits from high bond yields are helping them create reserves for their non-performing loans. Given the banks' reliance on these profits and the ministry's increasing appetite for money at any cost, the yields are not likely to come down soon.
"From the banks' point of view, it's great when the state must pay 25 to 28% on state bonds," said Peter Staněk, the ministry's state secretary. "It is maximally profitable for commercial banks, and these banks know that our state is in desperate need of capital."
Martin Barto, an analyst with ING Barings, agreed that banks were capitalizing on the ministry's impecunious position. "The main state-owned banks, like VÚB and Slovenská Sporiteľňa, are trying to cover their losses [stemming from] bad loans by asking high interest rates," he said.
But domestic banks were not alone in enjoying the meaty yields at state bond auctions, Barto continued. "High interest rates are also very advantageous to foreign banks, like Tatra Banka, which don't have these non-performing loans," he said. "They are making huge profits."
During the four May auctions, the maximum accepted yield on one year bonds fluctuated between 28.99% (May 19) and 29.5% (May 5). The feasters around the table showed a growing appetite, steadily pushing overall demand from 3.19 billion Sk at the beginning of the month to a record 11 billion on May 26.
Taxpayers or yieldpayers?
Ján Tóth, a research economist at Tatra Banka, said that he was "a little worried by these data," explaining that the extraordinarily high rates on bonds were creating outrageous arbitrage opportunities for money market players.
"Let's assume you are an investor with a one year horizon," Tóth said. "Currently, you have a choice between investing on the money market and in state bonds, but the difference in after-tax profit is 8.4% [in favor of bonds]. This is huge."
Furthermore, Tóth explained, players could borrow funds on the money market and sink them into state bonds for what he called an 'arbitrage profit', a rate differential that stood at 5.4% on May 19. Money market rates should be raised and bond yields lowered to eliminate the disparity, Tóth concluded. "[But] money market people may not be geniuses, so you may have to force them to do it," he said.
Barto pointed out that in this poker game between the ministry and commercial banks, Slovak taxpayers are again getting the dirty end of the broom. "[The arbitrage opportunities] are being financed with [Slovak] taxpayers' money. That's why it's not a very advantageous situation."
Selling bonds crazily
Staněk said that state bond yields were unlikely to fall sharply because the ministry was in dire financial straits. "We must have money for infrastructure projects," he said, citing Mochovce power plant, 100 kilometers of highways Slovakia wants to build this year, and a plan for Slovak Railways restructuring.
The second major stumbling block, Staněk continued, was repayment of maturing state debts. "In June, July and August, our instalment plan is too big, and in these months we must accept what we can get," he said. "Banks know this, and are preparing for it."
Barto noted that the ministry had already sold 25.78 billion Sk in bonds so far this year, although the 1998 state budget called for only 12 billion to be issued. "What is this extra money going to be used for?" he asked.
Staněk declined to comment, but Tóth opined that the ministry had seriously underestimated its likely 1998 fiscal deficit. "The fiscal deficit is supposed to be around 5 billion Sk, but given Slovakia's municipal debts, health care expenditures and infrastructure commitments, I would expect this deficit figure to wind up at around 20 billion Sk," he said. "This extra amount will be covered by newly issued bonds."
Restructuring the debt
The 90 billion Sk that the ministry must pay on maturing loans in 1998 represents state debt accumulated from 1994 to 1997, but is being covered mostly by shorter-term papers which analysts say merely postpones the problem for a future administration to deal with. Of the bonds issued so far in 1998, all but one (a 3.46 billion 2-year bond) have been one year papers bearing an average yield of 18%.
"I must say that this is a very dangerous moment, because most state bonds and T-bills are only one or two year maturities," agreed Staněk, adding he hopes the recent Eurobond issue will help restructure the debt's maturity. "We must have money that is a 3 or 5 year maturity, and this is why we prepared our strategy with Eurobonds," he said. (Please, see related story, below).
But Tóth said that the ministry was unlikely to place any longer term domestic paper in the near future. "Right now there is huge uncertainty regarding the political situation," he said. "Banks are extremely reluctant to give long-term stuff because most of their deposits are shorter term."
"It's election time, it's stupid time," conceded Staněk.