Since the middle of October the Romanian government woke up to the reality around it: funding will be more expansive, if you find it. It has tried to push for some capital control (force banks to keep their current exposure in Romania) but it has not worked. The latest idea, which is in fact an old re-heated one, is to sell government bonds to Romanian citizens.
The media picked it up and it went shopping for views from “independent” economists/analysts. The one that caught my eye belongs to the Chief Economist of Raiffeisen Bank and Head of The Fiscal Council. By the way, can he be both and how do we know when he speaks as one or the other? Nevertheless, here is a link to his opinion in Romanian. The essence of his message is that: selling bonds directly to households is a very good idea from any angle you look at it. Well, maybe on paper. Let’s see how this would work.
Before I go further I have to say that I am disappointed. Not in the political figures endorsing the idea but in the professional. To me, embracing such a proposal as a solution shows that how the monetary system works is not understood in Romania.
As I wrote a bit much, here is the punch line: it is the same money supply, so selling to households directly will not improve your funding costs.
If you still want to read I go through few examples below. .
The Ministry of Finance (MF) announces an issue of bonds for a 3 year maturity. What do you think that demand would be from that? One possibility is to look at the amount of deposits in the banking sector for that maturity. Don’t bother, I’ll tell you: is zero. And the situation is similar for maturities above one year. In fact, most of the retail money are kept in deposits with maturities lower than 6 months. Thus, theoretically the MF could find a source of funding but would not improve its poor management of debt financing.
Now, let’s look at the yields offered by MF for maturities up to one year. They are close to but below 7%. What is the interest offered on deposits by local banks? I just looked at the main bank in Romania and their interest rate ranges from 5.2 for a 1 month deposit to 6.20 for a 12 months one. Obviously, the term deposit is not the best substitute (different flexibility for example) for a t-bill but it will do for this fast analysis. Also, some banks will pay more for RON deposits depending on their liquidity situation. But for the sake of argument we assume all banks pay similar interest rates for RON liquidity. Thus, based on yields it looks like there might be some funds available for the MF.
However, these money are already in term deposits at those banks. Taking them out will mean that people will lose the interest rate. Thus, to make it worthwhile either the MF will have to do a great timing job and issue bonds when most of those deposits mature or it has to pay a premium to cover the interest loss. To make things even simpler, I only focus on the money already in the banking sector. I do not believe future disposable income will be any help here. In fact, we should discount by 25% the amount available in deposits at banks as it might be used by households for current expenditure.
Assume now all of the hurdles I mention are passed. Then, it looks like if the MF pays the same interest to households as it did for banks there might be some validity to this idea. Still, there is one more thing.
The households will take their money out of the banks and buy bonds. This money will go to the MF which will pay bills. This way money will get back in the system but unfortunately not in the same distribution as before. This means that some banks that do not have accounts with MF for paying pensions or salaries for state employees will have to raise interest rates to keep/attract savings. In fact, I guarantee you that banks will increase interest rates for RON liquidity the moment the MF will announce bond issues for households. This is the case of perfect foresight and it would be highly inefficient for them to wait. Why wait to pay more in the future when you can lock your savings for a bit more today?
As you can see, the idea might sound good but as usual only if you do not think about implications and implementation. I do not expect the president to understand this but I expect more from “independent” analysts/economists. Just because we want to change the owners of our bonds it does not mean more money are magically showing up. The money banks use to buy bonds are the money people deposit with them. It is the same money!!! The only authority that can increase or decrease the money supply is the NBR and they should not increase it to finance the budget deficit.