Covid-19 outbreak triggers sharp increase in public issuances
– how is this being handled and what is the effect?
Governments across the world, including the Danish government, have rolled out extensive financial packages to support individuals and businesses affected by the economic consequences of the coronavirus pandemic. In many wealthy countries, the support packages are record-breaking in terms of size and scope – and will significantly increase the governments’ financing. Below, Thorsten Meyer Larsen, Head of Monetary Policy Operations and Government Debt at Danmarks Nationalbank, shares his views and considerations regarding the government debt issues that have suddenly appeared.
The Covid-19 pandemic is having a huge impact on capital markets and government spending around the world. During a very volatile period, share prices plummeted, followed by a recovery for some companies. Interest rates for both government and corporate bonds have generally increased from the record-low levels from before the Covid-19 outbreak.
While the full economic effects of the pandemic remain uncertain, the economic outlook has deteriorated significantly since the Covid-19 outbreak began and the lockdown in many countries has the potential to lead to a deep recession. To counter the negative economic impact of the coronavirus pandemic, governments have launched large-scale support packages.
In addition, the European Central Bank has taken action to support liquidity and financing terms for households, businesses and banks. These measures are aimed at ensuring that all sectors of the economy can benefit from supportive financing conditions that enable them to absorb the Covid-19 shock.
Issuances in 2020
According to Danmarks Nationalbank, the issuance target for government bonds in 2020 is DKK 125 billion. Issuance of government bonds in DKK is the central government’s primary instrument to cover the long-term funding need. The central government’s on-the-run issues include nominal bonds with maturities of between 2 and 30 years, as well as an inflation-linked bond.
At the end of April, the issuance of government bonds for 2020 totalled approximately DKK 43 billion.
Treasury bills are short-term debt securities issued in Danish kroner. The programme can be increased via either auctions or tap sales, which are direct sales in the secondary markets.
Like the Treasury bill programme, the government’s two Commercial Paper programmes, one European and one US programme, are a source of short-term financing and are therefore well-suited to offset temporary liquidity shifts. The programs were activated at the end of March 2020, and central government's net foreign borrowing from January to April 2020 reached DKK 89 billion (DKK 80 billion in April 2020. The programmes will thereby contribute significantly to meeting the government’s funding requirement over the coming months.
Source: Danmarks Nationalbank
Huge financing need over the summer
The support packages adopted by the Danish Parliament require the government to increase its spending significantly, which entails a steep increase in the financing need in the immediate future.
In Denmark, the government debt is managed at Danmarks Nationalbank on behalf of the Ministry of Finance, and according to the latest estimate from Danmarks Nationalbank the government’s financing requirement is just over DKK 250 billion for the period from the beginning of April to the end of July. This estimate is subject to great uncertainty.
Even though we face a challenging situation for the world economy and public finances, Thorsten Meyer Larsen, Head of Monetary Policy Operations and Government Debt at Danmarks Nationalbank, believes that Denmark has a robust initial position: “Denmark benefits from many years’ responsible economic policy. Denmark has low public debt (at the end of 2019, the Danish central-government debt amounted to DKK 421 billion, or 18 per cent of GDP) and sound public finances. Denmark is one of few countries in the world to have achieved the highest credit rating, AAA, from all the major rating agencies. The Danish government thus has a good starting point to finance the expenditure related to the Covid-19 outbreak. Denmark furthermore has access to several sources of financing, both in domestic and foreign currency, and this ensures demand from a broad investor base. We are nonetheless aware that during this crisis, the financing need is expected to materialise faster and more suddenly, compared to earlier crises and downturns. This implies that in this situation the government needs to secure financing at a high pace over the coming months, and as always, we carefully consider the composition of financing sources as well as where to issue and via which infrastructure/CSD. In this regard, it is important for us to ensure the best possible access to investors and to meet their demands.”
The Danish central bank has a well-assorted toolbox
In “peacetime”, the Danish government’s debt policy follows a very predictable trajectory. Danmarks Nationalbank’s issuing strategy is announced for the coming year, which typically implies fairly constant issuance throughout the year.
“The sharply increased funding need in 2020, however, combined with global financial market uncertainty, makes it necessary for us to exhibit a higher degree of flexibility in our issuances. Therefore, we consider carefully how to make use of different funding sources, and whether to conduct short-term or long-term issuances, or whether to undertake issuances in Danish kroner or foreign currency. Our four funding sources are government bonds, Treasury bills, commercial paper and European Medium Term Notes (EMTN). On planning the use of the individual sources, we also aim to ensure that individual market segments are not burdened unnecessarily. Until now, we have used the three first-mentioned financing sources. So far, there have not been any EMTN issuances, but the programme is active, and the government can issue EMTNs within a short time. Under the EMTN programme, the government can issue relatively quickly in currencies for which the debt market is very deep, while reaching a diversified investor base in terms of both region and investor type,” Thorsten Meyer Larsen highlights.
During March and April 2020, Danmarks Nationalbank stepped up their issuances to cover the increasing expenditure related to the support packages: “As a large part of the government expenditure related to the support packages concerns initially temporary shifts in liquidity during the summer (for example postponement of tax and VAT payments), we have primarily used the short-term financing sources to meet the government borrowing requirement during the first phase of the Covid-19 outbreak. Other elements of the government support packages consist of direct expenditure that will not be returned (the wage compensation scheme, for example) and we will also see expenditure/reduced public revenue due to macroeconomic dynamics – the financing need as a consequence of these elements is more naturally financed through longer-term financing, such as government bonds,” Thorsten Meyer Larsen elaborates.
The general market turmoil and the extra issuances of corporate debt have generated high activity at VP. “At VP, we support the government issuances via our efficient infrastructure. All DKK-denominated government bonds and Treasury bills are settled and registered at VP – and we are well-prepared to handle the coming issuances over the summer period, should they choose to settle through VP. It is essential for VP to support a robust and well-functioning capital market,” comments Bjørn Stendorph Crepaz, Head of Issuer Products at VP.
Cautious optimism about coming issuances
“So far, the auctions of government bonds and Treasury bills have turned out quite positive – we experienced solid market interest and interest rates are still in the negative territory, although a little less negative than for previous auctions. So we are cautiously optimistic about the coming issuances, as Denmark is in a favourable position when it comes to achieving attractive financing conditions in the international debt capital markets. That being said, we are well aware that we are facing a challenging time in which countries around the world will need to increase their public financing significantly – we are respectful of the task we face in the immediate future and seek to be open and transparent about our strategies and planned actions,” Thorsten Meyer Larsen concludes.
In addition to the rapidly increasing need for government funding, VP expects the Covid-19 outbreak to have a marked impact on companies’ funding requirements: “Many companies are expected to have a need to raise capital and strengthen their balance sheets due to the sudden drop in revenue and earnings after the Covid-19 outbreak. For the time being, most companies are using their bank loan facilities to bridge the short-term need for liquidity, but during the next phase it is expected that companies will have a need to raise capital via both issues of corporate bonds and share issues. Since VP joined TARGET2-Securities, T2S, in 2016, we have been able to offer an attractive and efficient infrastructure for issuances in both DKK and EUR. We naturally hope that both Danmarks Nationalbank and other customers to an increasing extent will avail of the simple, cost-efficient and unified issuance process offered via the T2S platform. Via the T2S platform, we also offer access to a safe and secure distribution network through direct connection to important investor hubs such as Euroclear Bank and Clearstream Bank Luxembourg – enabling issuers to deepen the investor pool and easily reach their target investors,” Bjørn Stendorph Crepaz notes.
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