Government's inflation indexed bond programme faces delay until 2011, may be smaller than NZ$1 bln originally planned

By Gareth Vaughan

The Crown's first inflation indexed bond issue for 11 years looks set to be delayed until 2011 due to unfavourable market conditions with the overall programme likely to be smaller than the NZ$1 billion originally flagged.

Philip Combes, Treasurer at the New Zealand Debt Management Office (NZDMO), told interest.co.nz the prospect of the Government's debt issuer launching a Consumer Price Index (CPI) linked bond offer this month as previously planned was probably now less than 50-50. Market conditions were "not totally favourable" at the moment, Combes said.

"Broadly speaking we've been looking for linker issuance to stack up relative to the alternative of just continuing to issue our regular government bonds," said Combes.

In September the NZDMO named ANZ, Deutsche Bank and UBS as joint lead managers of its inflation indexed bond programme syndicate, with HSBC and RBS Australia as co-managers and said it was targeting a November issue of 15-year inflation indexed bonds.

The NZDMO flagged possible CPI linked bonds in May's Budget as part of an issuance of up to NZ$12.5 billion worth of debt in the 2010-11 financial year saying such bonds should provide long-term cost-effective funding for the Government and provide investors' with a hedge against inflation.

It hasn’t issued such bonds since 1999 with just one remaining on issue with a face value of about NZ$1.17 billion. It matures in February 2016. The return to CPI linked bonds came as the Treasury forecast inflation to almost treble to 5.9% next year and follows a recommendation from the Government's Capital Markets Development Taskforce and Australia’s reintroduction of indexed debt last year.

Combes said as it prepared to reintroduce inflation indexed bonds, the NZDMO was "wary" of how its previous issue has panned out.

"In the event (the bonds that mature in 2016) that turned out to be issued at real yields that were above 4.5%. So looking back that has proved to be an expensive issue," said Combes.

"So from our point of view we're keen to make sure that going forward we're doing these bonds at rates that are competitive (compared to)  just continuing to issue our nominal bond programme."

When planning the issuing of CPI linked bonds it made sense to look  back at average inflation over a reasonable period of time, Combes said. As a "rough guide" the NZDMO was putting average inflation over the past decade at 2.5% per annum. It was then considering whether there were any reasons why that ought to be different in the decade ahead.

"Which is what is actually going to count in terms of the cost effectiveness, - your estimate of what inflation looks like going forward, that's  the key," Combes added.

"We're still broadly comfortable with 2.5% (per annum) as a guide to future inflation expectations."

Based on the A$4 billion CPI bond programme launched by Australia last year and the smaller size of the New Zealand economy, for "planning purposes" the NZDMO had been talking about a NZ$1 billion CPI bond programme, Combes said.

But, given market conditions were now weaker, the ultimate deal size could be smaller than that.

"At this stage we're thinking up to NZ$1 billion but possibly a little lower," said Combes. 

"(But) we've not got to a position where we've made any hard and fast decisions on that."

If an issue doesn't go ahead this month, the NZDMO will wait until next year, after the Christmas and summer holiday period, when financial markets are up and running both locally and in Europe.

Both NZDMO officials in their marketing trips and the banking syndicate had sounded out some potential institutional investors to gauge their interest in CPI bonds, said Combes. Based on the initial feedback, at the lower end of a potential bond issue Combes was reasonably comfortable with the feedback, at the upper end the NZDMO wouldn't be issuing the bonds, and at the mid-point of the range, at this stage, pricing and interest was "still a little away from where we'd like to be."

Combes has previously told interest.co.nz that the inflation linked bonds should also be available to retail investors if banks buy them and sell them down in retail sized parcels.