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The Green Budget Funding issues and debt management January 2006 Professor David Miles +44 20 7425 1820

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Presentation on theme: "The Green Budget Funding issues and debt management January 2006 Professor David Miles +44 20 7425 1820"— Presentation transcript:

1 The Green Budget Funding issues and debt management January 2006 Professor David Miles +44 20 7425 1820 david.miles@morganstanley.comdavid.miles@morganstanley.com Niki Anderson +44 20 7677 6951 niki.anderson@morganstanley.com Morgan Stanley does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Please refer to important disclosures at the end of this presentation Overview: Public sector net debt is likely to continue rising as a share of national income over the next few years, but empirical evidence suggests that this is unlikely in itself to trigger higher real interest rates. Demand for long-dated assets by defined-benefit pension schemes is set to continue, but does not guarantee long term real interest rates will stay low. The Debt Management Office would benefit from locking in low real rates of interest now. Higher issuance of long-dated debt, significantly in index linked form, could also support cost effective wider pension provision. The proportion of debt outstanding in index-linked gilts has been broadly constant in recent years. But the DMO seems prepared to take a more flexible approach going forward. The Government may need to explore new ways to raise funds as debt reaches the 40% of GDP limit.

3 Please refer to important disclosures at the end of this presentation Public sector net borrowing 30.634.737.038.536.435.838.8 MS worse case 27.831.333.637.237.036.038.8MS central case 25.028.831.536.7 36.838.8Base case 1 22232631343738.8PBR 2010-112009-102008-92007-82006-72005-62004-5£ billion (1) Base case refers to IFS estimates based on PBR economic forecasts Source: IFS, Morgan Stanley Research estimates, HM Treasury

4 Please refer to important disclosures at the end of this presentation Public sector net debt 40.840.339.738.637.636.434.7MS worse case 40.139.839.438.637.636.434.7MS central case 39.639.539.238.637.636.534.7Base case 1 38.2 37.937.436.534.7PBR 2010-112009-102008-92007-82006-72005-62004-5% of GDP (1) Base case refers to IFS estimates based on PBR economic forecasts Source: IFS, Morgan Stanley Research estimates, HM Treasury

5 Please refer to important disclosures at the end of this presentation Outlook for gross gilt issuance 565958727051Morgan Stanley worse case 535655707151Morgan Stanley central case 5053 707152Base case 1 47 646852DMO/PBR illustrative gilt sales 2010-112009-102008-92007-82006-72005-6£ billion (1) Base case refers to IFS estimates based on PBR economic forecasts Source: HM Treasury, IFS, Morgan Stanley Research

6 Please refer to important disclosures at the end of this presentation How does gilt issuance affect yields? The projections are based on an assumption of no change in tax rates and spending plans – so they exaggerate the likely scale of gilt issuance. But more debt is likely. The interesting question is whether increased issuance is likely to bring about a rise in yields. Historical evidence suggests that this is unlikely.

7 Please refer to important disclosures at the end of this presentation Gilt issuance and yields Source: Bank of England, Debt Management Office

8 Please refer to important disclosures at the end of this presentation Change in debt to GDP ratios for G7 countries Source: OECD -30 -20 -10 0 10 20 30 CanadaFranceGermanyItalyJapanUnited Kingdom United States Debt to GDP ratio (%) Change in debt to GDP ratio 2000-05

9 Please refer to important disclosures at the end of this presentation International real yields on inflation proof bonds Source: Bloomberg

10 Please refer to important disclosures at the end of this presentation Long-term real interest rates on UK conventional debt Source: Morgan Stanley Research

11 Please refer to important disclosures at the end of this presentation Government debt and real interest rates Source: Morgan Stanley Research estimates, ONS, OECD, Global Financial Data

12 Please refer to important disclosures at the end of this presentation The sustainability of low interest rates: Whether or not low interest rates are sustainable is important for debt management. If todays low levels of real interest rates on government debt are here to stay then it is not so clear that locking in borrowing costs by issuing long dated bonds is necessarily the best strategy. But if the real cost of issuing debt is likely to be significantly higher than today in the next 10 years, then the cost of funding can be minimised by issuing long dated bonds now.

13 Please refer to important disclosures at the end of this presentation The sustainability of low interest rates: Global savings glut? Not big enough to explain large fall in interest rates

14 Please refer to important disclosures at the end of this presentation Global savings Source: IMF World Economic Outlook database (September 2005)

15 Please refer to important disclosures at the end of this presentation The sustainability of low interest rates: Global savings glut? Not big enough to explain large fall in interest rates Rise in risk aversion/lower GDP growth? Cannot account for fall in context of asset pricing model

16 Please refer to important disclosures at the end of this presentation The sustainability of low interest rates: Global savings glut? Not big enough to explain large fall in interest rates Rise in risk aversion/lower GDP growth? Cannot account for fall in context of asset pricing model Pension fund rebalancing? Most convincing explanation for current low levels But future impact on yields could be muted

17 Please refer to important disclosures at the end of this presentation Pension fund bond purchases versus gilt supply Source: Morgan Stanley Research estimates

18 Please refer to important disclosures at the end of this presentation Funding and funding strategy Source: Debt Management Office

19 Please refer to important disclosures at the end of this presentation Funding and funding strategy Source: Debt Management Office

20 Please refer to important disclosures at the end of this presentation Funding and funding strategy Strong case for significant funding from long-dated, substantially index- linked, debt. This case is strengthened if long-dated yields are temporarily beneath sustainable levels. It is not that one can be sure that we are in the midst of a bond market bubble - there are some reasons to believe that sustainable real yields may have moved down. But the scale of the fall in real yields is so great that the risks have now become asymmetric - the chances of real yields going higher from here are greater than their going lower. Locking in at todays low real yields by issuing long dated indexed debt is therefore sensible.

21 Please refer to important disclosures at the end of this presentation Buying back company pension liabilities David Willetts recently proposed that companies might be given the option of, effectively, selling to the government that part of their obligations to pay pensions to past and current employees that reflected the contracted out rebate. In principle the idea is simple, though in practice there are difficulties. There would be an economic gain if the cost to the public sector of having the obligation to pay higher state second pensions in future were smaller than the cost to companies of holding the same obligations. That would be true if companies were less able to manage the risks of holding those obligations – longevity risks and risks of assets underperforming.

22 Please refer to important disclosures at the end of this presentation Buying back company pension liabilities The issue of whether the government should buy some of these pension obligations from companies is similar to the question of whether the government should issue longevity bonds. But the government already has huge exposure to unanticipated rises in life expectancy. So it is far from clear that taking on more longevity risk is optimal. Buying pension obligations from companies would, however, generate substantial cash. If those obligations were not treated as on a par with government debt, then the strategy would ease the constraint that the 40% net debt limit creates.

23 Please refer to important disclosures at the end of this presentation Disclaimers


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