Treasury begins paying for losses incurred by the Reserve Bank

Treasury secretary Dr Caralee McLiesh has been given authority to spend $150-$200 million a month to pay for the losses the Reserve Bank is incurring on its large-scale asset purchasing programme.

Those payments will likely go up as New Zealand Debt Management begins to buy back government bonds from the Reserve Bank from this month.

The buy-back and payment of interest costs comes as part of the indemnity the Crown gave the Reserve Bank to cover any losses from the large-scale asset purchase programme (LSAP) the bank put into effect as part of its response to the economic effects of the Covid-19 pandemic.

In a paper to Finance Minister Grant Robertson on April 13, obtained by NBR under the Official Information Act, the Treasury said the Crown would soon have to start making payments to the Reserve Bank under the indemnity.

While payments of that magnitude normally required ministerial approval, the bank said it made sense to delegate the authority to McLiesh, otherwise the Treasury might have to come to Robertson every month to authorise payments the Government had to make anyway under the indemnity.

Treasury secretary Dr Caralee McLiesh.

“The payments to the RBNZ reflect rising interest rates and the announced sale of the RBNZ’s bond holdings to New Zealand Debt Management (NZDM). The first payment will be required in May 2022. Monthly payments indemnifying the RBNZ’s losses are forecast to be $150m-$200m per month and will continue until the LSAP bond portfolio is completely unwound, which is expected to be by 2027,” the paper said.

In an accompanying report it said initially the Treasury had received payments from the Reserve Bank of the net interest income it earned from the bonds. But as interest rates rose those payments fell from over $27m in July last year to just $1m for March this year.

The payments were expected to have reversed in April, with the Government now having to make payments to the Reserve Bank because of the higher interest rates.

“Additionally, the sale of LSAP bond holdings to NZDM commencing in July 2022 will mean the RBNZ will realise losses on the bonds it sells, which will also require payments from the Treasury under the indemnity arrangements agreed to by the Crown and the Reserve Bank,” the Treasury said.

It recommended delegated authority be given to the Treasury secretary to make the payments.

Robertson’s office confirmed that delegated authority had been approved by the minister.

Finance Minister Grant Robertson.

The paper said while the indemnity transferred the losses from the Reserve Bank to the Treasury it made no difference to the Crown’s overall balance sheet.

Initial cost not expected to be recovered

In an accompanying paper, it said initially the Reserve Bank had purchased government bond liabilities at $7.2b more than their original issue price. That led to a loss which was then expected to be fully offset by lower interest rates paid on settlement cash. Now though that was no longer expected to be fully recovered.

In fact, in answer to a question from Act leader David Seymour in Parliament last week, Robertson said the most up-to-date estimate was that the loss would amount to $8.46b.

Ironically, the reason for the LSAP now facing a substantial loss is because interest rates had risen considerably in the past year in response to the sharp rise in inflation.

“Further increases to interest rates will raise the amount required to be paid to the RBNZ each month,” the Treasury said.

The Reserve Bank next reviews the official cash rate on August 17, with most economists expecting it will raise it by 50 basis points and continue to do so at future monetary policy reviews.

Reserve Bank headquarters in Wellington.

As it does so that will increase the cost of the LSAP programme.

Despite that, the Treasury paper said the LSAP programme had been instrumental in supporting the Government response to the pandemic and the subsequent economic recovery.

“Most significantly, lower economy-wide interest rates reduced Crown finance costs and supported tax revenue by supporting broader economic output. The LSAP programme brought stability to financial markets early in the pandemic, when a surge in selling behaviour pushed up bond yields sharply and risked the effective functioning of the New Zealand bond market.”

Overall impact hard to measure

The paper said it was difficult to measure the overall impact of the package on the Crown’s accounts and the wider economy, but the Reserve Bank had estimated in August 2020, for example, that NZGB yields were at least 50 basis points lower, and possibly 100 lower, than they would have been without the LSAP programme.

It said those fiscal savings were not included in the Treasury’s assessment of the impact on the Crown’s financial statements but should be taken into account when calculating the overall cost of the programme.

Meanwhile, the National and Green Parties continue to call for an independent review of the bank’s monetary policy during the pandemic, a call supported by Act.

The bank though is already starting a review of monetary policy over the past five years, something it is required to do under the Reserve Bank Act. Within that review will be a specific assessment of the monetary policy tools it used in 2020 and 2021.

It was a requirement Robertson also made explicit in his letter of expectation to the chair of the Reserve Bank’s transition board, Professor Neil Quigley, at the end of March.

“The Covid-19 shock represents our first experience with implementing additional monetary policy tools, including large scale asset purchases and the funding for lending programme. I expect the bank to undertake a thorough review of the effectiveness of these policies, including the degree to which they provided economic stimulus, and the unintended distribution impacts of these tools, including the financial risks to the Crown’s balance sheet,” Robertson wrote.

He said he expected the bank to engage with the Treasury on the scope of the review and that it should inform decisions on the future use of those monetary policy tools.

The Treasury has confirmed the bank has engaged with it on the review as required by the minister’s letter of expectation.

A spokesperson for the bank said international experts in central banking would be involved as external reviewers, but they had not yet been named. The bank intended publishing the results of the review in November, although there was no plan yet to make a presentation to Parliament’s finance and expenditure select committee.

A New Zealand Initiative paper released last week – co-authored by former Reserve Bank governor Graeme Wheeler – had criticised central banks, including the Reserve Bank, for loosening monetary policy too much and said that was largely responsible for the spike in inflation.

Former Reserve Bank governor Graeme Wheeler.

Reserve Bank governor Adrian Orr has acknowledged the monetary policy committee’s decisions over recent years had influenced the inflation outcome, with the consumer price index now at 7.3%.

But the bank has also been at pains to point out that it was one of the first central banks to stop buying government bonds and to start raising interest rates.

The Treasury paper pointed out the bank stopped buying bonds in the middle of last year and ended up spending $54b of the $100b it had set as the limit for the LSAP programme. This month the bank has also begun the process of selling back about $5b worth of bonds per fiscal year to New Zealand Debt Management.

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