Borrowing in 2005

Central-government borrowing in 2005 was characterised by low market interest rates and a low borrowing requirement. Sale of domestic government securities totalled DKK 30.1 billion, mainly in the 10-year maturity segment. In addition, a euro loan of EUR 1.8 billion was raised.

The low sale reflects an extraordinarily high government surplus. In August, the sale of government securities was discontinued as a consequence of the improvement in government finances. Total sale of government securities exceeded the borrowing requirement by just over DKK 23 billion. The borrowing requirement in 2006 has been reduced by the same amount.

3.1 DEVELOPMENT IN INTEREST RATES

The decline in interest rates seen in 2004 continued until September 2005, cf. Chart 3.1.1. At year-end, short interest rates were slightly higher than at the beginning of the year, while long interest rates were approxi mately 50 basis points lower, implying a flatter yield curve, cf. Chart 3.1.2.

The falling interest rates until September were e.g. attributable to a general increase in uncertainty concerning the future economic growth in the euro area. Towards the end of the year, the indications of economic growth became more apparent and the risk of inflationary pressure more pronounced. This led to an increase in short interest rates in particular.^[1]

The decline in the 10-year interest rate in Denmark was stronger than in the euro area, and the 10-year yield spread to Germany became negative in the early summer of 2005, cf. Chart 3.1.3. Towards the end of the year, the 10-year yield spread stabilised just below zero.

The negative yield spread to the euro area among other things reflects supply and demand factors in Denmark. The high government surplus entailed a low supply of government bonds in 2005. On the demand side, life insurance and pension companies (L&P) in Denmark continued to purchase long-term government bonds, cf. Chart 3.1.4. Regulatory requirements pertaining to investment risk, capital base and liabilities in this sector imply that these companies have invested in bonds with long durations, cf. Chapter 9. Due to falling interest rates, the duration of the L&P companies' callable mortgage-credit bonds is decreasing. This can be countered by purchasing long-term government bonds.

During the last 18 months, non-residents sold long-term Danish government securities and purchased Danish government securities with shorter maturities. At the end of 2005, the total non-resident ownership share of Danish government securities was unchanged compared to the situation at end- 2004, cf. Table 3.1.1.

3.2 BORROWING REQUIREMENT

In 2005, Danish government finances showed an extraordinarily high surplus, resulting in a net financing requirement of DKK -79.4 billion. The government borrowing requirement for 2005 was DKK 20 billion, and sales of government securities totalled DKK 43.4 billion, cf. Table 3.2.1. The excess sale of government securities was thus DKK 23.5 billion. This correspondingly reduces the borrowing requirement in 2006, cf. Chapter 4.

The 2005 government budget surplus was adjusted upwards during the year reflecting higher estimates of economic growth in Denmark. There was also considerable revenue from pension-fund tax and North Sea activities as a consequence of the development in financial markets and the high oil prices. These items are difficult to predict. The government's borrowing requirement before buy-backs was approximately DKK 60 billion lower than the estimate in Budget Review 3, December 2004.

The issuance strategy was adjusted as the borrowing requirement changed. This led in early summer to a modification of the benchmark strategy to lower sales in the 2-year maturity segment, cf. Box 3.1.

The development over the year is summarised in Chart 3.2.1. After Budget Review 1 in May, issuance was reduced, and after Budget Review 2 in August, sale of government bonds was discontinued and buy-back was intensified.

3.3 BORROWING

Domestic government bonds
The central-government borrowing requirement is financed mainly by issuing domestic government bonds. In 2005, sales of government bonds totalled DKK 40 billion (market value), cf. Table 3.3.1. Half the sales during the course of the year were in the 10-year maturity segment, while approximately 30 per cent were in the 5-year and 20 per cent in the 2-year maturity segments. This distribution reflects the focus on building up the 5- and 10-year benchmark securities at the beginning of the year. In the 2-year segment, 3 per cent bullet loans 2006 was replaced by 4 per cent bullet loans 2008 in the government's on-the-run issues in May. At the same time, the latter series became the new 2-year benchmark.

Most of the government securities were sold in the 1st half of the year, cf. Chart 3.3.1.

Treasury bills
Issuance of Treasury bills in 2005 totalled DKK 73.7 billion (market value), while redemptions totalled DKK 83.5 billion, cf. Table 3.3.1. The net financing contribution from the Treasury bill programme was thus DKK ‑9.9 billion. The reduction was partly a response to lower demand at the last Treasury bill auctions of the year.

Treasury bills are issued at monthly auctions. For a more detailed description of the Treasury bill auctions, see Chapter 5.

Foreign borrowing
At the end of February, a syndicated euro loan of EUR 1.8 billion (DKK 13.3 billion) was raised, cf. Box 3.2. This loan covered foreign redemptions of just over DKK 9 billion. The surplus proceeds were carried forward to 2006.

The loan was priced on the German government yield curve, equivalent to a yield to maturity of 3.2 per cent, which was below the yield for other highly rated issuers. A good geographical distribution of investors was achieved, cf. Chart 3.3.2.

The CP programmes
The Danish government has two Commercial Paper (CP) programmes for short-term borrowing for up to one year in the international money markets. The two programmes are aimed at, respectively, the European market (ECP programme) and the US market (USCP programme). Under the USCP programme, all issuances are in dollars, while it is possible to issue in a number of currencies, including dollars and euro, under the ECP programme. The maximum outstanding amount in each programme is USD 6 billion.

The objective of the CP programmes is to ensure a liquidity contingency for rapid adjustment of the level of the foreign-exchange reserve over a short horizon, e.g. in connection with intervention. In addition, the programmes can be used when the balance of the central-government account is low.

The programmes were used in November 2005 to cover a short-term financing requirement on the maturity of 4 per cent bullet loans 2005. Issuances, primarily under the USCP programme, totalled approximately DKK 17 billion. The exchange-rate risk related to borrowing in dollars was converted to euro via forward contracts. The loans were raised in October and November, and matured in 2005.

3.4 Buy-backs

The central government buys back government securities in the secondary market. Securities that have been bought back are normally cancelled immediately after the transaction. Buy-back only takes place if it is assessed to be advantageous on the basis of an overall evaluation of government debt policy.

Buy-backs of securities maturing within the year do not affect the year's borrowing requirement. These buy-backs are aimed at smoothing the balance of the central-government account over the year.

Buy-backs of securities maturing in subsequent years are primarily used to maintain liquid on-the-run issues and to smooth the central government's redemption profile. These buy-backs increase the borrowing requirement in the current year, but reduce the borrowing requirement in the year of maturity.

Buy-backs in 2005 exceeded the volume in previous years, cf. Table 3.4.1. In particular, the buy-backs within the year were higher, among other things reflecting a large balance on the central-government account in the 1st half of 2005.

Most of the buy-backs in securities maturing in subsequent years were transacted towards the end of 2005, cf. Chart 3.4.1. This should be viewed in relation to the upward adjustment of government finances. These buy-backs mainly comprised 8 per cent bullet loans 2006 (DKK 21.1 billion) and were primarily purchased from the Social Pension Fund (SPF). SPF reinvested in securities with longer maturities, primarily 5 per cent bullet loans 2013, cf. Table 3.4.2. Overall, approximately 1/3 of the buy-backs by the central government and the government funds were in securities maturing in 2006, and almost half in securities maturing in 2013, while the rest of the buy-backs were distributed mainly on securities maturing in 2007, 2009 and 2011.

3.5 INTEREST-RATE SWAPS

Interest-rate swaps are used to separate the issuance strategy from the management of the central government's interest-rate risk, so that the issuance strategy can focus on building up liquid series.

By e.g. transacting interest-rate swaps from fixed to floating interest rates, the interest-rate risk is increased since a larger proportion of the debt is subject to current fixing of the interest rate.

Interest-rate swaps are transacted in both kroner and euro, which was also the case in 2005. The choice of market for transaction of interest-rate swaps is based on an assessment of the relative advantages of swaps in kroner and euro, cf. Box 3.3. If central-government transactions are deemed to have a potential impact on price formation in the Danish swap market, the transactions are conducted in the euro market.

CONSIDERATIONS ON TRANSACTING INTEREST-RATE SWAPS IN KRONER OR EURO	Box 3.3
The relative advantages of transacting interest-rate swaps in kroner or euro can be analysed by assessing the difference between the krone and euro swap rates today compared to the difference between 6-month Cibor and 6-month Euribor over the entire term to maturity of the swap. For instance, if the 10-year krone swap rate is 3.74 per cent and the euro swap rate 3.66 per cent, 8 basis points can be gained by receiving a fixed krone interest rate rather than a fixed euro interest rate. On the other hand, Cibor, not Euribor, is payable every six months. If Cibor on average proves to be more than 8 basis points higher than Euribor over the maturity of the interest-rate swap, the interest-rate swap in kroner will not be advantageous. In the 2nd half of 2004 and early 2005, the spread between the 10-year krone swap rate and euro swap rate narrowed by approximately 15 basis points, while the Cibor-Euribor spread fell by approximately 5 basis points. All other things being equal, it became more attractive to transact interest-rate swaps in euro.
RELATIVE PRICE CONSIDERATIONS, INTEREST-RATE SWAPS IN KRONER AND EURO, 2004-06
Note: All interest rates are adjusted for differences in maturities and shown as 5-day moving averages. Source: Bloomberg and own calculations.

Interest-rate swaps transacted in 2005 totalled DKK 14.3 billion, cf. Table 3.5.1. In January, the central government entered into 10-year contracts for DKK 1.8 billion in the Danish swap market, while all subsequent contracts were in euro.