- Short-term investors enjoy higher deposit yields
- Capital flows from lower returns to higher ones
- Attractive bond yields may reduce the liquidity further
- Other financial products may reprice
There are fears that the current liquidity squeeze has major implications on a number of things.
When the government has its own bond auctions for the longer term, why would anyone put money in a government bond for five or 10 years when they can put it in a flexible call and get 8 or 9 percent? Especially if aggressive deposit rates are somewhat limited to the short-term.
Asset managers have rushed to take advantage of these deposit rates and reportedly want to go long-term. Leading asset management firm Botswana Insurance Fund Management (Bifm) reported that during the first quarter of 2022, its Pula Money Market Fund returned 1.42 percent, significantly outperforming the benchmark return of 0.15 percent. On a 12-month basis, the Fund returned 5.22 percent, an outperformance of 464 basis points over the benchmark which returned 0.58 percent for the same period.
Bifm says in its report that the tight banking sector liquidity environment observed in the last quarter of 2021 prevailed during the first quarter of 2022, with banks competing aggressively for deposits amid growing demand for credit as the country continues to emerge from the COVID-19 pandemic and its effects on economic activity. “Short-term (Money market) investors, therefore, enjoyed higher yields over the quarter with average deposit rates rising considerably during the period.” African Alliance Portfolio Manager Jonathan Paledi explains: “One typically expects that, all other things equal, capital will flow from where returns are lower to where they are higher.”
Attractive bond yields may reduce the liquidity further
But an important point that Allan Gray’s Manager Director Phatsimo Ncube notes is that the 10-year government bond yield rose to 8.48 percent in June 2022 from 5.80 percent in May 2021, and it is the only long-term instrument that has reflected the high inflation environment that currently persists in Botswana and globally. “We expect other bond rates to rise in the medium-term, given the high inflation in Botswana and monetary policy rate increases,” she says adding that this will not only affect bond prices but also the cost of credit from banks. “If the yield on long-term government bonds becomes more attractive, we might see increased demand further reducing the liquidity in the market,” says Tapiwa Butale, CFO at Standard Chartered.
Other financial instruments may reprice
Where capital is mobile and moves from lower return-generating sources to higher return sources, Paledi argues that the net of this will be a repricing of other financial instruments in due course. In other words, if rates go significantly higher and this persists for a longer time, it may mean that everything ultimately has to reprice upwards. So the cost of credit is definitely under a lot of pressure and there is an imbalance in the market. “Cost of credit, on the other hand, has many moving parts stemming from a bank’s cost of funds to economic growth prospects, hence an increasing cost of funding coupled with a deteriorating economy will translate to higher credit risk and therefore higher credit spreads and ultimately higher cost of credit,” says Ratang Molebatsi, Finance Director at Access Bank Botswana.
In simple terms, Paledi explains, banks have to lend money at a higher rate than they borrow it, lest they generate negative net-interest-income margins. “These developments will lead to a narrowing of net-interest-margins and/or reduced borrowing, which would be detrimental to GDP growth and bank shareholder returns,” he says. “Higher deposit rates being paid will affect interest rate break-evens for loans and may lead to more expensive interest rates being passed onto borrowers”.
If funding cost continues to go up, there is a possibility of cost of credit going up as banks try to manage their Net Interest Income (NII), Butale adds. According to Bank of Botswana Statistics, interest expense in the market grew by 29 percent in April 2022 annually compared to a contraction of 3 percent that was reported the same period in 2021 due to rising cost of liquidity. Butale says this reflects increased funding cost. “To accommodate the increased cost of funding, banks may respond by increasing the lending rates,” she notes.
At this moment, some observers think it may be a bit premature to reprice but there are still industry players hinting signs. As a tip of the iceberg, Standard Chartered for example, has reportedly written to the government to say they are not going to accept the Government Employees Motor Vehicle and Residential Property Advance (GEMVAS) and the Local Authorities Motor Vehicle & Residential Property Advance Scheme (LAMVAS) schemes any more. The bank requested the government to review the schemes’ interest rates since it has been making losses through them in their present form. In a nutshell, the pricing does not make sense and these are the factors that banks look at as they try to grow.
Interventions
Observers say what you would normally have is some kind of policy intervention which, as in some countries, include discouraging investing in these short-term instruments. Other markets have added disincentives on short-term instruments. They will charge higher withholding tax on short-term instruments, indirectly penalising for being in the short-term.
Paledi says BoB also has a range of tools in its policy playbook, should they see it necessary to intervene. Some of these include targeted liquidity injections, lowering reserve requirements, lowering capital adequacy requirements and easing liquid requirements. Butale calls for more ways to ensure that the current deposits invested offshore by pension funds can be invested onshore. “The banking market, together with BoB, need to come up with innovative ways of generating sustainable liquidity in the market.” Molebatsi argues that the government and the central bank can use policy changes only to a certain extent. However, commercial banks and financial institutions need to introduce instruments that can bring efficiency and good returns in the market. “The central bank has made good strides in the recent monetary policy changes,” says Molebatsi. “This was to primarily ensure that market rates are interlinked and the passthrough effect of the change in the policy rate spills over to assets and deposits.”
Liquidity plumbing
There is some good news. Debswana is a big spender and is coming to the market with its Citizen Economic Empowerment Programme (CEEP). Diamond sales have also improved. Another factor is that there are some measures that the central bank has put in place for banks to be able to borrow funding. With the Monetary Policy Changes, BoB has introduced the Standing Credit Facility (SCF) which also allows the banks to access funding from it overnight. That has never been the case and the market has never had that in the past. While there was a repo market, it was not accessible.
Further, general elections are on the horizon and government is expected to start spending. Some funds are expected to flow through by H2 next year. The big problem is that the Botswana market is very much dependent on the government and if government does not have money, there will be liquidity pressure. Infact, if anyone of the big contributors of liquidity moves funds, there tends to be a squeeze. Observers however expect the market to enter 2023 in a better position. Read more: Experts say banks will weather near term liquidity challenges
