You have to pay more
The change in the price of money in the financial market is the main influencing factor that has to be taken into account by those who want to borrow, including countries, to refinance their previous obligations. In addition to the financial market processes, the interest rates of each specific country are also determined by its financial situation, as well as how long the government borrows money by issuing debt securities, and of course the amount of money that needs to be raised is also very important. For example, in the Eurozone, the southern countries of the region – Greece and Italy – have had the biggest problems with financial discipline, and it was the latter that attracted the most attention in previous years. Namely, the Italian government debt reached 155% of the country’s gross domestic product in 2020 (for comparison – Latvia had 43.3% of GDP at that time), and there were occasional fears that this country could follow in the footsteps of Greece if the financial market economy started change for the worse. Importantly, Italy is the third largest economy in the Eurozone. A year ago, the country’s 10-year bond yield was above 2% per annum, but now it is above the 4% mark. It must be said: the good news is that in the previous two years, Italy has managed to reduce the amount of its debt in relation to GDP, therefore the current rise in rates has not yet affected the country too much financially, and recently bond yields have even decreased by a penny. However, it is quite safe to predict that problems may start when the European Central Bank’s fight against inflation drags on and it needs to raise interest rates for a longer period of time. This can cause problems not only for Italy or Greece, but also for a wider range of countries. For now, it looks like Latvia will not be among them.
It is also more expensive with us
Debt that a couple of years ago could be refinanced in the bond market in the medium term by borrowing at a 0% rate has now become significantly more expensive. As shown by the latest auctions of bonds issued by the state, the mentioned securities can be sold to the investor with a yield of approximately 3.7-3.8%, lending this money to the state for five years. It should be said here that the government had set the bond coupon rate at 3.5%, which means that bond buyers bought them slightly below the nominal value. This is nothing terrible and only indicates that there is a desire for a slightly higher return of money than the Latvian state was initially prepared to offer by borrowing from potential lenders. The good news is that demand for our sovereign debt remains very high and exceeds supply. If we talk about the recent measures for the sale of state securities, then in the auction held on March 22, investors’ demand for bonds exceeded the amount offered by the State Treasury by 67.2%. On the other hand, a week earlier, when government bonds with a maturity date of October 7, 2026 were sold, the demand for government securities was 62.9% higher than the supply. Thus, the good news is that the government, while paying more than before to service its debt, can refinance its obligations without much stress. Such a financial market conjuncture also opens opportunities for Latvian residents to invest money in conservative and fixed financial yield instruments with higher yields. In addition, more profitable than bank time deposits. In this sense, the easiest and most profitable way is to buy Latvian government savings bonds, where the purchase process itself is very simple, but promises a good financial return, if you take into account that, at least in the short term, it can be considered almost as a risk-free investment, and in addition, no income tax is payable on the obtained profit. For example, in the savings bond offer of April 5, Latvian residents had the opportunity to lend their money to the state with a yield of 3.55% per year for 12 months, 3.65% per year for five years, and 4% per year if the money in savings bonds is lent for a period of 10 years. . It must be said that an offer of this nature is better than when money is lent to commercial banks through a deposit.
Latvia is ready for the new period
The fact that interest rates have risen and the world’s governments have to pay higher interest than before when they borrow money should not be seen as an emergency. In fact, large-scale government bond purchases by central banks have taken place as a result of the economic stimulus of the last decade, when central banks worked to get commercial banks to lower lending rates. This reduced the loan rates and at the same time drove the yield of bonds to the historically lowest level, which was atypical and even allowed Latvia to borrow at a negative rate for a while.
Now the monetary situation has turned in the opposite direction, and here it is important that the financial situation of the country is such that it allows to return to the times when the current interest rates could be considered the norm or even a little too low. From the answers to the questions put to the Ministry of Finance by the “Independent”, it can be concluded that our country is ready for this. According to the ministry, debt service expenses will return to approximately the level they were before 2016, when the national debt was significantly lower than it is now. The amount of interest expenses, even after the increase, is still, in the view of the ministry, considered moderate, because the amount of debt obligations, which is approximately twice as large, will cost the state budget approximately the same as before the period of low interest rates.
In response to the question of whether the possibility of amending the state budget is envisaged in the event that interest rates become so high that there are not enough funds for the coupon payments of newly issued debt securities, the ministry states that according to the current indicative forecasts, there is no reason to believe that with the state budget for 2023 the intended funds might not have enough money to cover the expenses of servicing the national debt. Therefore, amendments to the 2023 state budget law will not be necessary. The FM also draws attention to the fact that coupon (interest) payments for government bonds issued this year will have to be paid starting next year. Therefore, the state budget is safe for the time being, and there is reason to believe that next year interest rates will be lower than at present, which may once again give new opportunities to think about attracting cheaper monetary resources.
