It hasn’t been a very good few months for the Australian State Treasury Corporations. While the ongoing global financial crisis (GFC) has been challenging for everyone dealing in the financial markets, conditions really got difficult for the States when banks began issuing bonds with Commonwealth Government guarantees back in December 2008. Things got worse last week when Standard & Poor’s announced a downgrade of Queensland Treasury Corporation (QTC) from AAA to AA+. Many investors are concerned that New South Wales will be next. Perhaps the time has come for the States to give up their borrowing programs and move to a centralised Commonwealth borrowing model.
Despite the guarantee, the yields on these bonds were high: close to 2% higher than debt issued directly by the Commonwealth Government. Many of the institutional investors who bought these bonds raised the money by selling bonds issued by the State Treasury Corporations. Both the State Treasuries and the Commonwealth boasted AAA ratings. But, with its ability to directly raise tax revenue, the Commonwealth will always be seen by investors as the lower risk option, and so their borrowing costs are lower. But before the GFC, the difference in cost faced by the States was relatively small, at around 0.20-0.40%. Even before the issuance of Government-guaranteed bank debt this difference had begun to increase, but when investors saw a 2% premium offered by guaranteed bank debt, it is no surprise that they looked attractive compared to State Government debt. If you had the choice between CBA bonds with a guarantee from the Commonwealth Government and NSW Treasury Corporation bonds with a lower yield, which would you choose? As a result, market prices adjusted, pushing up yields on State Government debt, closer to the levels of the guaranteed bank debt.
While the premium on guaranteed-bank debt has reduced somewhat since December, State Government debt remains under pressure and any further ratings downgrades will not help. I would not be surprised to see their yields drift higher, ending up above yields on guaranteed bank debt and, to make matters worse, liquidity has also deteriorated. Trading in State Government bonds has declined and transaction costs for investors have increased and it will certainly be harder for the States to find investors for the new issues that their infrastructure development will require in the coming year. QTC alone, according to their December investor booklet, has borrowing requirements for this year of around A$10 billion. Even if borrowing costs do not deteriorate further, the cost of servicing this debt will be around $100 million more than it would be if the money was raised by the Commonwealth.
Some would argue that the whole point of giving the States responsibility for raising their own finance is to impose fiscal discipline. But how well does this seem to be working? And is this fiscal discipline worth paying 100s of millions of dollars each year? With the Commonwealth considering taking control of the health care system from the States, perhaps they should look at financing as well.