ON THE RIGHT: Let the buyers beware
GOVERNMENT SAVINGS BONDS were an attractive investment even prior to the recent deregulation of the minimum savings rate.
The yield to maturity of 5.5 per cent tax-free is even higher considering that ordinarily interest received is subject to a withholding tax of 12.5 per cent. By not suffering the withholding tax, the effective yield rate is therefore higher.
But the savings bonds are effectively a loan to the Government of Barbados repayable within five years. Here are the likely effects of the savings bonds: the local portion of Government’s overall loans will increase, debt service will increase (interest), and more loans on Government’s books could lead to further downgrades if loans are not used productively.
There is a risk of Government being unable to repay bonds when they become due, and if Barbadians withdraw their funds (deposits) from the commercial banks in significant amounts to buy Government paper, the commercial banks might be forced to raise the minimum savings and deposit rates.
If this occurs, savings bonds might not be fully subscribed or be attractive to Barbadians. The commercial banks’ ability to lend could be hampered if significant funds move from commercial banks to prop up Government finances. The present issue of $10 million should not be cause for concern, but is this likely to be a trend?
If we get into instances where you say $100 million, $200 million, or $300 million in savings bonds then, of course, that’s adding to Government’s debt. The $10 million is also adding to Government’s debt, but they may be saying to you that’s manageable so therefore the risk is not as great, but you have to juxtapose that with what is happening otherwise, these bonds that they are doing, debentures and so forth.
And if there comes a time when Government is so stretched that the revenues are not coming in but the loans are going up, there could very well be a default.
We have St Kitts and Grenada, they issued bonds as well and about three years ago St Kitts was so stretched they eventually went to the International Monetary Fund.
They had to cut the bonds, if you had $100 million in bonds those were cut by 50 per cent. The more debt you pile on there are questions as to whether you can service it.
Government, like anybody else, can default on them. If you believe that things are getting worse rather than better, then if you have a five-year bond you have to decide whether you want not to wait until the five years because you don’t have to wait for five years, you can cash in these savings bonds after a year or a year-and-a-half and at that stage you can decide whether you want to wait for the five years to get the yield of 5.5 per cent that they are offering.
So it’s going to require the person who is investing to watch what’s happening with Government’s revenues, what’s happening with the loans profile and generally in the scheme of things what are they doing to ensure that the economy gets back on track and make your decision on that basis.
Douglas Skeete is a chartered accountant.