A SURGE of global demand for Australian government bonds has saved the federal government from issuing at least $10 billion in debt, cutting more than $500 million a year from its future interest bills.
The surge, which is the flipside of investors fleeing the turmoil of Europe, has slashed the yields on Australian bonds and cut the cost of issuing new debt by more than 20 per cent.
The latest 10-year Commonwealth bond issued this month had a yield of just 3.81 per cent, in contrast to an average of 5.33 per cent in 2010-11.
The latest five-year bond issued a week earlier had a yield of just 3.46 per cent, down from an average of 5.47 per cent in 2010-11.
Bond yields in recent months have been at or around the lowest levels in 60 years. This has created an unexpected bonus for the federal budget, significantly lifting the likelihood of a surplus in 2012-13.
The yield is the expected return to investors. Yields are falling because more investors want to own Australian bonds and are prepared to accept a lower return to do so.
Falling yields do not change the interest bill the government pays on existing debt. But they have a big impact on the cost of issuing new debt, and the cost of servicing that debt in future.
The chief executive of the Australian Office of Financial Management, Rob Nicholl, said the fall in yields had meant investors buying new issues were generally paying more than the face value of the bond.
To buy a $1 million bond paying interest at the old levels, an investor might now have to pay $1.1 million or more.
"If the cost of borrowing is lower, then it's good for Australia," Mr Nicholl told The Age. "When yields are lower, the price we receive for issuing bonds is higher and that means we can issue less face-value debt to raise the required amount of money."
The effect of the lower yields has been so dramatic that it absorbed the full impact of the estimated 2011-12 budget deficit blowing out from $22.6 billion in May to $37.1 billion in the midyear outlook released in November.
That would normally need a comparable rise in government borrowing. But Mr Nicholl said the Office of Financial Management still planned to issue $53 billion of new debt this year, the same target it had in June.
"It's the product of a whole lot of influences," he said. "Australia is a AAA-rated sovereign, and that's a shrinking club. Investors might be taking money out of equity markets and putting it into the safety of bonds paying fixed interest.
"There have been changes in currency level and hedging costs. It's not surprising that demand for Australian government securities should have risen in the current circumstances."
Reserve Bank assistant governor Guy Debelle said this week the demand for Australian bonds was coming largely from the sovereign wealth funds of foreign governments.
Mr Debelle said the Reserve estimated that 75 per cent of Australian bonds were owned offshore. He said foreign demand for Australian bonds could be partly responsible for the recent strength of the Australian dollar.
On back-of-the-envelope estimates, a 20 per cent fall in average yields on new bond issues in 2011-12 would allow Australia to issue at least $10 billion less debt than would otherwise have been needed.
In turn, that would save the budget more than $500 million a year in interest it would have had to pay on that debt.
