Fiscal needs are spurring government bond issues

Government bond issuance in Trinidad and Tobago was relatively quiet in 2016, with just two new issues of government debt coming to market, totalling TT$2.16bn ($322.7m). This would have come as a surprise to most market participants, particularly given the budgetary requirements to meet target spending. However, 2017 is likely to see increased issuance as maturities of central government and government guaranteed domestic debt of over TT$7bn ($1bn). All else held constant, issuance activity should increase as the fiscal gap between recurrent expenditures and revenues widens.

Market Rebounds

Activity on the secondary T&T dollar bond market spiked in 2016, hitting a six-year high in terms of traded value. The value of bonds moving across the T&T Stock Exchange in 2016 was TT$1.85bn ($276.4m), almost 22.5 times the value of trades in 2015 of TT$82m ($12.3m). Institutional trade volumes, unsurprisingly, dominated market activity. It would appear that major institutional investors engaged in a rebalance of their portfolios throughout the year, with most activity taking place in longer-term bonds.

The pace of increase in bond yields slowed over 2016, though the upward trend remained very much intact. Throughout 2016, the Central Bank of T&T’s Monetary Policy Committee maintained its benchmark repo rate at 4.75%. Ongoing expectations of increased government borrowing have pushed short-end and mid-curve yields up. Year-on-year, the greatest movement was in the belly of the yield curve, where 10-year government bond yields moved up some 48 basis points (bps) from 3.88% to 4.36%. One-year government bond yields also advanced 26 bps, from 2.55% to 2.81%. Interestingly, the long-end of the yield curve remained relatively constant at 6.14%, a 3-bps increase from the end of 2015. The short-end and mid-curve rate movements suggest the market is expecting considerable government borrowing within the one-year to 10-year maturity profile. This is somewhat surprising, considering the government bond’s maturity profile has the most capacity for additional domestic debt in the 17-25-year space, long-end rates have barely moved and long-term borrowing rates in T&T dollars are still reasonably low.

The yield curve’s growing belly is being reflected in yield spreads. The 1/10 yield spread, which is the difference between 10-year and one-year government bonds, widened 22 bps from 1.33% to 1.55%, while 10/30 spread, which is the difference in yield between 30-year and 10-year bonds, actually compressed 45 bps from 2.23% to 1.78%. The data suggests that investors perceive short-term risks to be increasing relative to longer-term risk for government T&T dollar paper.

Credit Rating

In April 2017 the sovereign credit rating of T&T was downgraded by both major international ratings agencies Standard & Poor’s (S&P) and Moody’s to “BBB+”, remaining investment grade and “Ba1”, which is considered junk bond status, respectively. Regional ratings agency Caribbean Information and Credit Rating Services also adjusted its rating for government bonds in June 2016, from “CariAAA” to “CariAA+”.

Moody’s and S&P had broadly similar rationales for the downgrade, with the ratings agencies blaming a lack of prudent fiscal policies. Moody’s explained that measures taken by the government were “insufficient to effectively offset the impact of low energy prices on government revenues, as fiscal consolidation efforts have mostly relied on one-off revenue measures.” A consequence of the recent downgrade could be higher borrowing costs for the government.

Facing headwinds of constrained energy production, relatively muted energy prices and a wide fiscal gap comprising much recurrent expenditure, there is a high likelihood that T&T will receive at least a one-notch rating downgrade in the year ahead. Although inflation remains in check, borrowing needs and credit quality will likely be key influencers in the direction of local and international bond yields. Overall, both retail and institutional investors should have more access to T&T-dollar and US-dollar options along the yield curve.