The government borrows from the local and international markets to help fund its budget. Individuals and organisations with funds available to lend short term, medium term, and long term are able to earn safe, reliable income.
The government is very much like you when it comes to managing its budget. To spend more than you earn, you generally borrow. When the government does not collect enough taxes to support its spending, it resorts to borrowing locally and abroad from individuals, banks, pension funds, companies, and unit trusts, for example – who buy its debt instruments. These lenders – like those who grant loans to you – earn income, generally interest.
Two examples of financial instruments that the government uses to borrow from the Jamaican public are treasury bills and benchmark investment notes.
Treasury bills are short-term instruments of maturities ranging from 30 days to 365 days and are issued by the Bank of Jamaica (BOJ) on behalf of the Government of Jamaica (GOJ). They are issued at a discount by way of a competitive tender and mature at par – face value. The investor’s return is the difference between the discounted value and the maturity value. Though not described as interest, it is income nonetheless, and is taxable.
Treasury bills assist the GOJ primarily to fund its short-term budgetary needs, as well as to manage liquidity in the financial system. Thus, government does not have to rely solely on taxes and long-term borrowings to fund its annual budget.
The money invested in the securities also serves another purpose. It effectively removes liquidity from the financial system, and reduces the spending capacity of consumers while their funds remain invested. One possible consequence of this is the lowering of the demand for foreign exchange, which helps the Jamaican dollar to maintain its value. On the other hand, as it earns income, the opposite is also possible.
Investors find treasury bills beneficial as they are low-risk and liquid – liquid because they can generally be sold by a securities dealer for the investor relatively quickly. Beyond that, treasury bills are an attractive alternative to fixed deposits at financial institutions, but are less accessible to some investors than others.
Individuals bidding for treasury bills from the BOJ must bid in its monthly auction through authorised brokers via the JamClear CSD system. They may also buy bills on the secondary market – on which bills already owned by another investor or even the securities dealer – trade.
Treasury bills trade on the money market, but benchmark investment notes trade on the bond market.
Benchmark investment notes are typically fixed-rate debt instruments issued by the GOJ to fund its budgetary needs. They typically mature in five to 35 years. Interest is generally paid every six months and is taxable. They are auctioned through competitive bidding auctions via BOJ’s JamClear CSD system, and investors must use a designated stockbroker, primary dealer, or commercial bank to submit their bids. They, however, trade on the secondary market, where stockbrokers are particularly useful.
They are low-risk, provide a known and predictable income, and are suitable for conservative investment portfolios, but also fit well into higher-risk portfolios for diversification and income. The difference between how they fit into conservative portfolios and aggressive portfolios is their percentage in each. The big drawback, though, is their low level of inflation protection – the longer the term of the instrument, the lower the inflation protection afforded the principal at maturity, meaning the less and less the principal can buy at maturity as its maturity extends.
Although not as liquid as treasury bills, benchmark investment notes can be sold before their maturity date through a securities dealer. Being fixed-rate instruments, though, means that their price tends to move opposite to the direction in which interest rates move, so there is potential for capital gain or capital loss.
You benefit from treasury bills and benchmark investment notes when you buy them directly or through a dealer for your own account. But you benefit in other ways: when you invest in a unit trust or mutual fund that invests in them, when you own a life insurance policy linked to funds that invest in them, and when your pension fund invests in them.
If you are a pensioner, or are approaching retirement, these instruments may fit well into your investment portfolio.
Government debt instruments are generally safer than corporate debt instruments, which may pay more to reflect the higher risk. They are suitable instruments to add to your investment portfolio for income and safety of principal; the more conservative you are, the higher their weight in your portfolio.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com
