Ottawa has been boasting for five months about its strategy to lock in low interest-rate costs by shifting its bond issues to long-term maturities, a move that would reduce the risk that today’s record deficits would turn into spiralling debt costs years from now.
The government’s desire to shift away from short-term bonds would be familiar to any Canadian with a variable-rate mortgage, worried about interest rates eventually increasing. Locking in now delivers the security of predictable interest costs, of particular concern to those with large mortgages – or with record-busting budget deficits.
However, the government’s debt-management strategy has been mostly talk, with little action. The average maturity of the government’s debt issues fell to a 25-year low in July, when then-finance minister Bill Morneau first talked up the notion of locking in low debt costs to take advantage of the steep drop in interest rates since the onset of the coronavirus crisis. In the ensuing five months, there’s been only a modest rebound in the average maturity of those debt issues, now at its lowest point since July, 2013, as shown in the chart below.
Conservative finance critic Pierre Poilievre has sparred with Finance Minister Chrystia Freeland over the government’s assertion that it is moving to cement in lower interest costs. “It’s not clear we are locking in low interest rates at all,” he said in an interview ahead of the economic update.
Treasury bills, with maturities of a year or less, have dominated debt issuances so far in this fiscal year, reflecting both the demand from buyers for short-term issues to park excess cash and the government’s need to raise large amounts of cash quickly to fund its coronavirus spending.
Through to mid-November, 61 per cent of gross issuances were treasury bills, higher than the government’s goal of 47 per cent for the year as a whole. Conversely, long-term debt issues, with a maturity of 10 years or more, are running behind plan. Just 9 per cent of debt issued so far this fiscal year is long term; the debt-management plan calls for 15 per cent of gross debt issued this year (including treasury bills) to be long term.
Of course, some of those treasury bills will mature in this fiscal year and will need to be refinanced, giving the government the opportunity to roll that debt over into longer-term maturities. And the dollar amount of long-term debt (along with short- and medium-term debt) has risen sharply this year, with the total amount of bonds with maturities of 10 years or more rising to $159.8-billion as of Nov. 1, up from $134.4-billion as of April 1.
The Finance Department did not directly respond to a question of why there has been relatively little long-term debt issued so far this year. However, in a statement it reiterated the tenets of the debt-management strategy, and added that the government intends to increase the proportion of long-term bonds issued as it rolls out stimulus spending.
Despite the department’s reticence, there are some clues contained in the July and November economic updates. First, the government noted this week that it turned to treasury bills in the early days of the coronavirus crisis, since it needed to raise a large amount of money in a short time.
The government also signalled in July, and again this week, that it was sensitive to the bond market’s capacity to absorb long-term debt. The Department of Finance and the Bank of Canada launched consultations with market participants in part to explore that issue; the Bank of Canada released a summary of those consultations the same day as the fall economic update, in keeping with past practice.
“Market participants indicated that the Bank of Canada’s Government Bond Purchase Program (GBPP) was the key factor in raising the unprecedented amount of long-term federal government debt in an orderly manner, since the GBPP absorbed a significant portion of the extra issuance,” the summary said.
Translated from the deliberately bland language of central banking, that statement hints that the central bank’s interventions have been needed to allow the government to issue as many long-term bonds as it had. “That’s a rather telling phrase because it suggests that the market would have suffered indigestion if the Bank of Canada hadn’t been in there,” said William Robson, chief executive officer at the C.D. Howe Institute.
In an interview, Benjamin Tal, deputy chief economist at CIBC World Markets, noted that a delay by the government in moving to longer-term debt would have the temporary benefit of reducing interest costs since issuers need to pay a premium to sell longer-term maturities. Again, there are similarities to the homeowner looking at a move to a fixed-rate mortgage. The fixed rate gives peace of mind, but typically comes at the cost of a slightly higher interest rate.
Kevin Page, president and CEO of the Institute of Fiscal Studies and Democracy, said in an e-mail that those benefits would be fleeting and could lead to higher debt costs in coming years if longer-term rates rise in the meantime. (Indeed, yields on 10-year Canadian bonds have moved up slightly from the summer, although they are at less than half the level of January.)
Mr. Page, the former parliamentary budget officer, noted that other governments are moving in a similar direction. The Liberals pointed to this fact in the economic update, going on to point out that Canada has outperformed two of its G7 peers, Japan and the United States, by locking in a greater proportion of debt issued in 2020 as multiyear bonds. That boast is narrowly true, but leaves unstated the fact that Germany, Britain, Italy and France have all moved much more aggressively than Canada, as the chart below from the economic update shows.
And the assertion that Canada has outperformed Japan and the United States is only true if all bonds other than treasury bills are included. If only the long-term bonds with maturities of 10 years or more are counted, then Canada falls behind Japan, beating out only the United States.
Ultimately, the debt-management strategy can only limit, not eliminate, the threat of rising debt costs, Mr. Robson noted. Already, the government is projecting that debt costs will increase by more than $10-billion over the next five years, projected to rise from $20.2-billion in fiscal 2021 to $34.3-billion in 2026, shown in the chart below.
Those estimates likely understate debt costs. They don’t take into account the government’s planned stimulus spending of $70-billion to $100-billion over three years, nor the cost of major new expenditures telegraphed in the Throne Speech, such as pharmacare and child care. And they are predicated on interest rates rising only slowly in the next few years.
Mr. Robson has some blunt words for anyone in government trying to find a way to mitigate the risks of Ottawa’s debt burden. “If there’s concern about rising interest costs, borrow less.”
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