Five months have passed since the first publicly expressed idea about issuing government bonds (announced by Minister Primorac in the autumn). Now the conditions are somewhat known, specifically that they will be issued within the third quarter, for a term of two years. The coupon, or interest, will not be less than three percent, although there is speculation in financial circles about five percent.
The minister briefly stated that the goal of the shorter maturity is to make borrowing, or investing their savings, acceptable for citizens, while explaining what kind of instrument it is and what its advantages and limitations are. The idea is for citizen buyers to hold them until maturity, as that is when the risk is lowest, and the certainty of achieving promised returns is highest.
Reactions are varied, mostly positive regarding the benefits that buyers, i.e., citizens, will have. Milan Horvat, director of FIMA Plus, briefly commented on his LinkedIn profile that if the interest is around five percent, citizens will earn ten to even 50 times more than from the savings they hold in banks, with even better prospects in the future.
– Namely, the worse the government performs, the worse the situation in the country will be, and interest rates on bonds will, of course, rise. This will finally allow the people to start earning money from the incompetence of Croatian politicians, and I admit, this is already a serious investment opportunity – he wrote, adding that he hopes the smallest denominations of bonds will be at least 10 euros, and not above 10 thousand and higher, as they have been issued so far, concluding that he is interested in how liquidity trading in that bond will be maintained.
Higher interest than in banks
Such issues are usually illiquid, as they are rarely traded on the secondary market – citizens generally hold such issues until maturity, which makes it difficult for the state to discover the market price and interest rates of those bonds, according to which the state could determine those parameters for some future, new issuance. However, that is the state’s concern; what citizens planning to invest in bonds need to know is that the interest (in bonds, it is called a coupon) is calculated on the price at maturity, i.e., at the end of the redemption period, and the price is known in advance at the time of purchase. In this way, the state borrows on the domestic market instead of abroad and from citizens instead of institutional investors (banks, funds, insurance).
Igor Vihnanek from InterCapital provides an illustration for purchasing a five-year bond with a yield of three percent: if someone invests, for example, 10 thousand euros in such bonds and waits, say, five years for the state to return the invested amount, the state will, in the meantime, pay three percent interest on a specific date every year during those five years (although it is not the same, it can serve as a comparison – buyers of shares in INA and HT from the time of the IPO until the moment they decided to sell the shares received dividends every year – if the company assemblies decided so).
Government bonds are like regular bonds, only with one difference – they are intended for ordinary people. It seems they will be issued in two parts; if anything remains after the offer to citizens, it will be offered to institutional investors. However, it seems that the coupon/interest for citizens will be somewhat higher. What is also important is the announcement that the minimum amounts (if prescribed) will be set quite low, thus making them more accessible to all citizens, i.e., the amounts required for purchase will not be as high as usual.
What do government bonds offer citizens at all, and why could they be profitable? Vihnanek specifies that they could offer citizens a higher interest rate in the long term than investing in bank deposits. – If citizens receive an interest rate of three or four percent through government bonds while their long-term deposit in euros in banks offers an interest rate of 0.28 percent (data from December 2022), it would make more sense to buy government bonds.
The least risky security
Contrary to the general impression of citizens, government bonds are considered the least risky security within a financial system, i.e., they are less risky than deposits in banks in Croatia.
It is often mentioned that bank deposits are state-insured, which citizens see as an additional benefit, but many do not trust that the same state will return their money increased by interest if they buy government bonds. Otherwise, government bonds offer citizens instruments for long-term investment with a fixed interest rate. It is difficult to arrange a deposit in banks for 5 or 10 years, while government bonds can be issued and are often issued for such terms – explains Vihnanek, adding that they also have drawbacks that need to be watched out for.
Namely, when a saver wants to terminate a time deposit, the bank returns at least the principal or the principal with some reduced interest. If someone bought government bonds with a maturity of five years but wants to exit the investment after two years – they must sell the bonds.
– It may happen that at that moment the market price of the bond is higher, but also lower than the one at which you bought it. This means that upon sale, you could incur a capital loss. For the two years you held the bond, you will receive the full interest, and there will be no loss of interest, but the market price is not guaranteed. Namely, the idea is not to issue government bonds and then trade them continuously over the years. This can lead to a situation where if you want to sell a bond with a maturity of five years after just two years because you need money – you may not be able to do so at the price you desire – explains Vihnanek.
In addition, there are also some transaction costs – if you want to sell government bonds, you will also have to pay, for example, brokerage fees. If you have invested relatively small amounts in bonds, for example, less than two thousand euros, those costs could be too high relative to the investment.
Pro et contra
Financial blogger Sandra Ferenčak briefly summarized the ‘pro et contra’ of purchasing government bonds, although there is still too little known about the whole matter.
Thus, the advantages for small investors could be: an interest rate (coupon) of around three percent, which is better than what can be ‘earned’ by holding money in a bank (around 0.30 percent); there should be no restrictions on the minimum deposit amount; holding the bond until maturity (two years) has a low risk of non-payment of the nominal amount (principal) except in the case of state bankruptcy; the interest on the bonds is tax-exempt.
Of course, there are also disadvantages such as: additional investment in government bonds alongside already significant amounts invested (future pensions) in the second and third pillars; in the case of rising interest rates, the value of the bond falls, which means that in the case of sale before maturity, you are exposed to the risk of price change; the interest rate (coupon) does not cover expected inflation (this year inflation is estimated at seven to eight percent, thus it will be twice as high as the coupon).
Whatever you decide with any surplus you would like to invest more profitably than bank interest, a term of two years is not too long, it is unlikely that the state will go bankrupt, and with such a purchase, you would certainly contribute to the growth of overall financial literacy. After all, isn’t it said: do not ask what the state can do for you but what you can do for the state! So, finance it.
