The fading global economic recovery, the increasing likelihood of a double dip recession in the United States and the European sovereign debt crisis casts a bleak economic outlook for the upcoming fiscal year. With these factors in mind, many citizens pondered what initiatives the 2011/2012 budget would contain to boost the faltering local economy. The fiscal package presented by the Minister of Finance, which was geared towards achieving economic transformation, contained initiatives aimed at ensuring the greater use of public-private partnerships to stimulate growth and competitiveness and a thrust towards job creation. While the debate on the effectiveness of these new initiatives continues, for local investors, the budget included several new measures aimed at invigorating the local capital market. If implemented, these measures can expand the saving and investment opportunities available to the local investor. In this piece, we will discuss some of the salient investment initiatives presented and the potential effects on the local investor.
Budget arithmetic 2011 Review
Last September, in the first fiscal presentation under the current administration, the Minister of Finance projected a budget deficit of $7.7 billion(5.48 per cent of gross domestic product) for the 2011 fiscal year. This projection was based on an oil price of US$65 per barrel (WTI spot price) and natural gas price of US$2.75 per mmbtu (Henry Hub spot price, net-back). However, during the course of 2011, the Government revised the budgeted oil price upwards to US$75 per barrel, while maintaining the projected natural gas price. For the 2011 fiscal year, actual WTI spot prices were 24 per cent over the budgeted oil price. On the other hand, the actual price of natural gas was 18 per cent below the budgeted price (Table 1).
2012 fiscal year
Following the trend of the past three years, the 2012 fiscal year is expected to produce a budget deficit of $7.6 billion, a marginal decline from last year's projected $7.7 billion (4.89 per cent of GDP) deficit. As such, for the fourth consecutive year, the country will have to rely on deficit financing to meet its planned expenditure (Figure 1). With 2012 government revenues projected at $47 billion and expenditure at $54.6 billion, 52.7 per cent of the deficit (approximately $4 billion) will be financed locally, while the balance is expected to be sourced from "external sources including multilateral financial institutions." In the 2012 budget, last year's forecasted energy prices were maintained at the budgeted price of US$75 per barrel for WTI oil and Henry Hub natural gas at US$2.75 per mmbtu (net-back). It should be noted, the one-year futures price of WTI is above the budgeted price of US$75 per barrel, as illustrated in Table 2. However, for natural gas, the larger contributor to energy revenues, the one-year futures price (net-backed) is below the 2012 budgeted price.
Capital market initiatives
For the local investor, the budget presented several new initiatives aimed at increasing activity in the local stock exchange. For instance, the proposed listing of several state enterprises such as First Citizens bank and the T&T Mortgage Bank (which will be a merger of T&T Mortgage Finance Company and Home Mortgage Bank), will increase the options available to local equity investors. Similarly, investors will also benefit from the implementation of the Junior Stock Exchange and small and medium businesses will be able to access alternative forms of financing. The Clico payout issue was also addressed in the budget presentation. The Minister of Finance reiterated Clico policyholders will obtain an initial $75,000 payment and 20 annual zero-rated bonds.
Additionally, it was disclosed that a Clico Trust Fund will be established and investors can exchange their 11-20 year bonds for units of the trust fund, which will be traded on the local stock exchange. It was also proposed that the income and dividends obtained from the units of the trust fund will be exempt from taxes.
On the local fixed income side, with approximately $4 billion of the budget deficit being financed locally, the expected government bond issues will aid in reducing the relative scarcity of TT$-denominated debt. However, more than likely the Government will not conduct its local deficit financing plans to issue TT$-denominated bonds until the Clico bonds are issued and listed on the stock exchange.
The market ramifications of the upcoming government deficit financing remain uncertain. Currently, excess liquidity within the financial sector continues to keep interest rates low, with the latest Central Bank Monthly Report estimating excess liquidity to be $4.6 billion in September. If the upcoming bond issues aid in mopping up excess liquidity within the financial sector, there may be some upward pressure on domestic interest rates. However, this scenario is unlikely as the Clico bonds are not expected to materially impact liquidity levels. As such, the system could remain flush with funds and interest rates may remain at their current low levels or even decline. Thus, there is likely to be downward pressure on the lower end of the yield curve. Alternatively, the surfeit of issues could place pressure on the longer end of the curve, as investors' capacity to invest in that period may be limited. Institutions' ability to purchase government issues may be constrained leading to a rise in rates at the long end.
Recommendations
Based on the initiatives outlined in the budget, there are significant potential benefits for the local investors who wish to invest in the medium- to long-term. Depending on their personal circumstances, Clico policyholders may want to consider exchanging their longer term bonds for units in the Clico Trust Fund.
Additionally, given the uncertain interest rate environment, cashing in one-ten-year bonds may be considered as long as prices are fair. For instance, if the Government issues TT$ bonds in the amounts expected and the excess liquidity within the financial system is reduced, interest rates will increase and policyholders will find the value of their bonds declining.
As such, to reduce this uncertainty investors may look to sell their one-ten-year bonds and seek out suitable investments, which will provide a fixed rate of return. The Government's plan of local deficit financing and equity listings should increase the supply of local investment options and investors in the medium- to long-term should use this opportunity to expand their local portfolio. However, with domestic interest rates being at such low levels on the short end, investors can also look to invest in the international fixed-income markets. By investing in quality credit issues and using a hold-to-maturity-approach, investors can lock in fixed rates of return in the medium term.
Bourse Securities Ltd
askus@boursefinancial.com or
624-0000/628-6204
