By R.M.B Senanayake
The Government faulted the Central Bank for carrying out negotiations for the purchase of government bonds. They seem to have a naïve faith in the tender procedures. But do they provide the best market price?
What does Economics teach about markets? Markets enable the best price to be obtained only where there is perfect competition or something close to it for perfect competition is only an ideal and the degree of competition varies from market to market. The strict conditions for perfect competition require a large number of buyers and sellers in the marketplace to ensure a competitive market price. It also requires that the buyers and sellers compete among themselves.
Auctions are one method of having a market place. An auction is like a well defined game. You can write the rules for a tender and the government regulations lay down such conditions. Generally the auction allows the seller and the buyer to quote a price. Buyers may have a valuation for the object that they want to buy. They do not know the valuations of the other bidders and sometimes they may not even make their own valuations unless they have the information of the market prices that already prevail.
Bidders who are prospective buyers need to recognize that their bids only matter when they win the auction. They will win the auction only when they bid the highest or the best price. They may be more optimistic than other bidders or more pessimistic. If it is the former and they expect the market price to go up in the immediate future, they will bid a comparatively higher price. When the tenders are opened they will realize whether they were too optimistic or too pessimistic.
Auctions vary
From the buyers perspective there are choices about how an auction is designed. Auctions can be open bidding like in the auctions conducted by the licensed auctioneers. Alternatively they can call for sealed bids where the seller (or buyer) receives bids and then proceeds to open them at a pre-determined time. Alternatively, bidding may be interactive where each bidder has an opportunity to outbid the previous higher bidder. There are also different ways to use bids received by the auctioneer to determine the price. The seller may consider the total revenue obtainable although governments are sometimes more concerned about efficient allocation.
Both the revenue and the efficiency are affected by the design of the auction. One key question the seller must consider is how the design of the auction will affect the participation of the bidders, as this will determine how competitive the bidding will be as well as whether the object gets to the potential bidder who values the item the most.
When I first joined a private sector firm I wanted to buy some goods for the company. Following the usual practice in the government sector (where I had worked before) I wanted to call for tenders but when I mentioned it to my boss he said it was not necessary and a waste of time. Instead he told me to go to the Pettah market and make inquiries from several merchants and then decide on the best prevailing price and bargain based on the size of the quantity of the purchase. The purchase of goods on tender is mostly confined to the public sector.
Tenders seem to be intended more to ensure fairness to all possible suppliers rather than obtaining the best offer. It is to ensure fairness among the suppliers rather than to achieve an efficient allocation. So the rigid version of the tender procedure is more or less confined to the public sector.
The Bond Market
Now consider the primary bond market consisting of those registered as primary dealers. This is a small number. There is only one buyer and it is the government. The government’s demand for money is practically unlimited. But it can’t obtain the entire supply in a single auction because the market capacity is limited. So the Public Debt Department of the Central Bank calls for weekly offers from the primary dealers. If there is an urgent need for money which cannot wait, it can always borrow from the Central Bank or the Bank of Ceylon promising to repay it with the proceeds of the next auction.
The Central Bank acts on behalf of the government to raise the money for the government. It has therefore a dual role. The Central Bank generally has a reserve price in mind. It is mindful of the need to keep interest rates low both to benefit the Treasury and to uphold its interest rate policy and also not to allow abrupt changes in the interest rate for it affects the whole structure of market interest rates in the inter-bank system and even affects the capital market. Similarly the tendering parties can select the level of the reserve price, how long the auction will last and the government buyer can decide whether to buy it now or wait for the next week.
With reference to the episode on the recent controversial bond issue, the Central Bank has said that the government made known its need for a larger quantity of money before the tender was closed. But the Central Bank perhaps knowing the market conditions did not want use this higher figure of demand when calling for tenders. Why? Perhaps because if it did so the Bank would push up the interest rate immediately by taking up the higher priced offers which it could not have done without accepting the higher interest offers. So while the demand of the government is always or often there, the Central Bank’s Public Dept Department which knows the market conditions will tread with caution.
The tender if strictly followed would require the buyer to accept only the best offer. But the buyer also requires taking into account the quantity of the supply offered and what quantity it requires. It can keep the price unchanged from its previous level if it accepts less. But the demand of the government is always urgent and cannot be put off - at least not for the whole quantity. Strictly it should accept only the quantity for which the tender called for although it could accept less for it may mean a lower interest rate for that supply. Is it wrong to negotiate with the bidders after the tender is opened? Some in authority seem to think so. But in a small market the bidders may not be able to supply the full quantity needed by the government. In such an event, the government may need to take all the leading offers until it gets the required quantity. Is there anything wrong in then negotiating? Who thinks so? Those who say so perhaps don’t appreciate the market conditions and the governments demand. The Bank wants to get the total quantity but without pushing up the interest rates. If the tender bids order was strictly followed in order then the government would have to pay a higher average interest, there can be no objection to negotiation after the tenders are opened to get the best price for the government.
The primary dealers were sponsored as a market by the Central Bank and were not a spontaneous springing up of a market. In any case the history of English banking show how the Bank of England supported and sustained the Discount Houses. (Vide Lombard Street: A Description of the Money Market (1873) by Walter Bagehot) In fact it is this tradition that led to the evolution of the lender of last resort and even the practice of orthodox monetary policy.
Fairness
The ideas about economic fairness are not exclusively economic ideas. They touch on politics, ethics and religion. Economists have inherited such ideas from politics and religion. All ideas about fairness can be divided into a broad group. They arise from the idea that they are not fair if the result isn’t fair. It is also not fair if the rules are not fair. Consider the idea that the Central Bank while acting on behalf of the government to raise the money must have some reserve price in mind. Similarly the parties can select the level of the reserve price, how long the auction will last (if open auctions) and the buyer can decide whether to buy it now or wait for the next week’s auction. The Central Bank Governor has said that the government made known it its need for a larger quantity of money before the tender was closed. But the Central Bank did not use this demand figure when calling for tenders. Why? Either because the information was conveyed after the tender was closed or perhaps because the Bank knew that the market did not have the capacity to supply the larger quantity; or if they called for the larger quantity the Bank would have to accept much higher offers and thereby push up interest rates when it could have avoided it. The tender procedure strictly requires accepting the best offer. But the buyer must also take into account the quantity of the supply he wants to buy.
Thinking about fairness can be divided into two broad categories. One is to argue that it is fair if the result isn’t fair. The second is that it is not fair if the rules governing the sale are not fair. In the private sector the main concern is with obtaining the best price. That is the criterion of fairness. In this case the result isn’t fair.
In the private sector the main consideration is to get the best price. The attention to procedures is not the prime consideration. But it is not so with the public sector. But let us not think the tender procedure is the best in the world.
www.island.lk
The Government faulted the Central Bank for carrying out negotiations for the purchase of government bonds. They seem to have a naïve faith in the tender procedures. But do they provide the best market price?
What does Economics teach about markets? Markets enable the best price to be obtained only where there is perfect competition or something close to it for perfect competition is only an ideal and the degree of competition varies from market to market. The strict conditions for perfect competition require a large number of buyers and sellers in the marketplace to ensure a competitive market price. It also requires that the buyers and sellers compete among themselves.
Auctions are one method of having a market place. An auction is like a well defined game. You can write the rules for a tender and the government regulations lay down such conditions. Generally the auction allows the seller and the buyer to quote a price. Buyers may have a valuation for the object that they want to buy. They do not know the valuations of the other bidders and sometimes they may not even make their own valuations unless they have the information of the market prices that already prevail.
Bidders who are prospective buyers need to recognize that their bids only matter when they win the auction. They will win the auction only when they bid the highest or the best price. They may be more optimistic than other bidders or more pessimistic. If it is the former and they expect the market price to go up in the immediate future, they will bid a comparatively higher price. When the tenders are opened they will realize whether they were too optimistic or too pessimistic.
Auctions vary
From the buyers perspective there are choices about how an auction is designed. Auctions can be open bidding like in the auctions conducted by the licensed auctioneers. Alternatively they can call for sealed bids where the seller (or buyer) receives bids and then proceeds to open them at a pre-determined time. Alternatively, bidding may be interactive where each bidder has an opportunity to outbid the previous higher bidder. There are also different ways to use bids received by the auctioneer to determine the price. The seller may consider the total revenue obtainable although governments are sometimes more concerned about efficient allocation.
Both the revenue and the efficiency are affected by the design of the auction. One key question the seller must consider is how the design of the auction will affect the participation of the bidders, as this will determine how competitive the bidding will be as well as whether the object gets to the potential bidder who values the item the most.
When I first joined a private sector firm I wanted to buy some goods for the company. Following the usual practice in the government sector (where I had worked before) I wanted to call for tenders but when I mentioned it to my boss he said it was not necessary and a waste of time. Instead he told me to go to the Pettah market and make inquiries from several merchants and then decide on the best prevailing price and bargain based on the size of the quantity of the purchase. The purchase of goods on tender is mostly confined to the public sector.
Tenders seem to be intended more to ensure fairness to all possible suppliers rather than obtaining the best offer. It is to ensure fairness among the suppliers rather than to achieve an efficient allocation. So the rigid version of the tender procedure is more or less confined to the public sector.
The Bond Market
Now consider the primary bond market consisting of those registered as primary dealers. This is a small number. There is only one buyer and it is the government. The government’s demand for money is practically unlimited. But it can’t obtain the entire supply in a single auction because the market capacity is limited. So the Public Debt Department of the Central Bank calls for weekly offers from the primary dealers. If there is an urgent need for money which cannot wait, it can always borrow from the Central Bank or the Bank of Ceylon promising to repay it with the proceeds of the next auction.
The Central Bank acts on behalf of the government to raise the money for the government. It has therefore a dual role. The Central Bank generally has a reserve price in mind. It is mindful of the need to keep interest rates low both to benefit the Treasury and to uphold its interest rate policy and also not to allow abrupt changes in the interest rate for it affects the whole structure of market interest rates in the inter-bank system and even affects the capital market. Similarly the tendering parties can select the level of the reserve price, how long the auction will last and the government buyer can decide whether to buy it now or wait for the next week.
With reference to the episode on the recent controversial bond issue, the Central Bank has said that the government made known its need for a larger quantity of money before the tender was closed. But the Central Bank perhaps knowing the market conditions did not want use this higher figure of demand when calling for tenders. Why? Perhaps because if it did so the Bank would push up the interest rate immediately by taking up the higher priced offers which it could not have done without accepting the higher interest offers. So while the demand of the government is always or often there, the Central Bank’s Public Dept Department which knows the market conditions will tread with caution.
The tender if strictly followed would require the buyer to accept only the best offer. But the buyer also requires taking into account the quantity of the supply offered and what quantity it requires. It can keep the price unchanged from its previous level if it accepts less. But the demand of the government is always urgent and cannot be put off - at least not for the whole quantity. Strictly it should accept only the quantity for which the tender called for although it could accept less for it may mean a lower interest rate for that supply. Is it wrong to negotiate with the bidders after the tender is opened? Some in authority seem to think so. But in a small market the bidders may not be able to supply the full quantity needed by the government. In such an event, the government may need to take all the leading offers until it gets the required quantity. Is there anything wrong in then negotiating? Who thinks so? Those who say so perhaps don’t appreciate the market conditions and the governments demand. The Bank wants to get the total quantity but without pushing up the interest rates. If the tender bids order was strictly followed in order then the government would have to pay a higher average interest, there can be no objection to negotiation after the tenders are opened to get the best price for the government.
The primary dealers were sponsored as a market by the Central Bank and were not a spontaneous springing up of a market. In any case the history of English banking show how the Bank of England supported and sustained the Discount Houses. (Vide Lombard Street: A Description of the Money Market (1873) by Walter Bagehot) In fact it is this tradition that led to the evolution of the lender of last resort and even the practice of orthodox monetary policy.
Fairness
The ideas about economic fairness are not exclusively economic ideas. They touch on politics, ethics and religion. Economists have inherited such ideas from politics and religion. All ideas about fairness can be divided into a broad group. They arise from the idea that they are not fair if the result isn’t fair. It is also not fair if the rules are not fair. Consider the idea that the Central Bank while acting on behalf of the government to raise the money must have some reserve price in mind. Similarly the parties can select the level of the reserve price, how long the auction will last (if open auctions) and the buyer can decide whether to buy it now or wait for the next week’s auction. The Central Bank Governor has said that the government made known it its need for a larger quantity of money before the tender was closed. But the Central Bank did not use this demand figure when calling for tenders. Why? Either because the information was conveyed after the tender was closed or perhaps because the Bank knew that the market did not have the capacity to supply the larger quantity; or if they called for the larger quantity the Bank would have to accept much higher offers and thereby push up interest rates when it could have avoided it. The tender procedure strictly requires accepting the best offer. But the buyer must also take into account the quantity of the supply he wants to buy.
Thinking about fairness can be divided into two broad categories. One is to argue that it is fair if the result isn’t fair. The second is that it is not fair if the rules governing the sale are not fair. In the private sector the main concern is with obtaining the best price. That is the criterion of fairness. In this case the result isn’t fair.
In the private sector the main consideration is to get the best price. The attention to procedures is not the prime consideration. But it is not so with the public sector. But let us not think the tender procedure is the best in the world.
www.island.lk
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