In our previous publications we have written about the complaints connected with the bonds issues by the state. As this topic needs much information, we are writing about it one more time to understand the reasons of those debates.
Journalists and experts are accusing the government in establishing high interest rates for state bonds as banks are becoming more interested to use their resources to buy these bonds instead of being interested in financing the economy. In other words, by defining high price for the money the government is forcing investment resources out of the economy and leaving the economy without money.
The ministry of finance is also accused in building a financial pyramid. This means that the government is borrowing money with interest rate from its own society, and next year it borrows more to cover the debt, thus increasing the debt year by year. It is worth mentioning that increasing domestic debt is not a bad thing if the economy is developing normally. This means that they can solve certain problems with those borrowings (such as paying foreign debt, etc.) if the tax incomes are not sufficient for the state to implement their projects.
First of all let’s understand what the ministry of finance is accused in. There are a number of banks in Armenia which have a certain amount of money. Banks are recruiting money with X interest rate, and giving to third parties with Y interest rate, which is higher. The more interest rates they add to the initial interest rate, the more income they will have. It is when the state appears on the stage. The government offers bonds (i.e. it is ready to take borrowings from banks) with the market interest rates. For banks the state is the most reliable client, so they prefer giving their resources to the state than private persons. Now let’s discuss the high interest rates for these bonds.
It is worth mentioning that the ministry of finance itself does not offer a price (interest rate) for bonds. The prices are offered by the market participants, i.e. banks, and the prices are defined during an auction based on the offers. It means that if experts are complaining of high interest rates, they should criticize banks first of all. However, some experts criticize the ministry of finance for not forming the interest rates formally but for instructing these prices informally. However, the ministry of finance refutes this opinion and claims that it does not instruct any interest rates.
It is also important to understand whether the interest rates for state bonds can compete with the interest rates for borrowings offered to private persons and businesses by banks.
Chart 1 illustrates the interest rates for state bonds according to the terms of coverage.
According to the information above, in the end of the last year the average rate of state bonds was 11.6%. The rate of mid-term and long-term state bonds was 12.3%, and the rate for short-term bonds was 10%. Now the rate for short-term bonds is approximately 9%. This means that the government borrows money for approximately one year term with 9-10% interest rate. Banks give such borrowing easily and in 2010 they have provided 62 billion drams with 10% interest rate.
What was the interest rate offered to private persons and businesses by banks (which is formed according to market mechanisms as well)? Chart 2 illustrates information concerning a number of Armenian trade banks.
As we can see, the interest rates for borrowings in AMD up to one year are almost twice higher than the interest rates of state short-term bonds. It means that in case of short-term state bonds the interest rate does not matter much. Banks have preferred to provide 62 billion drams to the state with 10% interest rate instead of giving it to the private sector that offered twice more money for that borrowing (banks have provided only 14.6% short-term credits to the private sector). This may seem nonsense but there are reasons for it.
As for mid-term and long-term bonds with 3 and 5 years term of coverage, during 2010 mid-term bonds were allocated with the average value of 43.3 billion drams with the average interest rate of 12.395%.
Are the interest rates of mid-term state bonds so high that banks prefer giving the money to the state rather than to the private sector? In fact trade banks offer mid-term credits with interest rates starting from 15%. However, as a rule banks give borrowings for interest rates higher than 15% (17-18%). In addition to this money banks also take other payments from clients such as application fees, etc. In case of large and long-term credits banks are trying not to give borrowings in drams. They provide borrowings mostly in foreign currency, thus leaving the risk of currency exchange rate on clients.
The same chart shows that the capacity of credits provided in 2010 was only 15.6 billion drams, while in foreign currency the capacity of provided credits reached 142.2 billion drams (long-term credits). In a word, by providing credits to the business sector banks can receive 5-7% more interest rates than by buying short-term bonds from the government.
Now we will try to discuss the influence of long-term state bonds (7, 10 and 20 years) on credits. Firstly, our banks do not provide borrowings for 20 years (especially in AMD). As for the borrowings with 10 years term of coverage, these are mainly mortgage credits, which are provided with 12% interest rate but due to the financial support of international organizations. This means that banks are receiving the main resources for giving credits from other sources and cannot direct that money for other purposes. In a word, the interest rates of state bonds do not have much influence on the policy of trade banks. This is even proven by the credit portfolio statistics. Thus, in the end of 2010 the credit portfolio of trade banks was approximately 900 billion drams, and the price of state bonds was 173 billion drams. Even if we assume that the entire capacity of bonds was purchased by trade banks, it will be equal to the 19% of their credit portfolio only.
Let us also mention that currently in the black market they lend money with 60 and over percent interest rate. It means that especially small businesses have demand for financial support, which the trade banks cannot supply because of very strict and limited terms and conditions. Now let us understand this situation, which seems very unclear at the first sight. It turns out that the trade banks refuse from their profits voluntarily and offer their resources to the state at cheaper price. The thing is that when lending money besides interest rates they consider a range of other factors. They consider whether the credit taker is able to pay back the credit, what reputation it has and what mortgage it can offer. It means that they are trying to find reliable debtors. And currently it is not very easy to do so and the trade banks are furiously competing to have such customers. That is the reason why the banks prefer state obligations by avoiding extra tension and sufferings. Why would they accept applications, examine select cases and then appear in fuss because of unpunctual customers. It is better to give the money to the state even with lower profit expectation but be on the safer side. Simply said, this is a bright example of civilized “laziness.” And the trade banks don’t care very much that because of their laziness economic activeness suffers. It means that the whole problem is connected with the safety guarantees that the trade banks need. They formulate it as a guarantee of stability but it gradually turns into glutted market.