Commentary: A nice idea proves complicated

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The Independent Online
Ever found a tenner in the pocket of a jacket you haven't worn for years? The Treasury has found nearly pounds 3.8bn stuffed away at BT and the electricity companies, and is feeling just as pleased.

In fact, it was not so much an oversight as a deliberate stashing away for a rainy day. The debts owed by the companies to the Government could have been sold off at the same time as the original privatisations, but that would have swollen the size of the public offers and made them even more difficult for the markets to digest than they were.

Much better to keep the potential revenue for later years when the need might be more pressing. With gilt sales this year likely to be at least pounds 35bn, that time has arrived, and the Treasury's original decisions to keep back the debt have been vindicated.

Unfortunately, a nice idea has proved exceptionally complicated in practice. It would have been simplest to package the pounds 1bn of debt initially on offer and market it as a sterling bond, perhaps through a tender offer or a straight auction.

But the operation would have been expensive, involving marketing campaigns and lots of executive time on roadshows explaining the companies to investors all over again. It would also compete rather too directly for comfort with the gilt funding programme, where top-rated corporate bonds of this quality are a higher yielding option for investors.

The Barings solution, involving redemption of the debt, certainly has the advantage of cheapness, and it also encourages the companies to use some of their own funds to pay off the government.

But it has proved rather a nightmare. Much of the fixed-interest rate debt was issued at high rates, and therefore now trades at a premium to its nominal or par value. If the company redeems its own debt, it loses the tax relief on the high interest coupon. Indeed, there are also tax penalties for many tax-paying investors if they buy debt at over par. This is the explanation for the apparent subsidy available to companies buying back their own debt, through a discount on the price.

In fact, it is not a cost to the taxpayer at all, on Barings' arithmetic. The Treasury benefits from the redemption because tax deductions are lower and its tax revenues are higher than they otherwise would have been.

As for private sector buyers, Barings believes there are enough British and international funds around that can sidestep the tax problem to make a genuine market.

All very neat and useful, but it does suggest that this is an exercise that cannot be repeated too quickly. Given the sheer size of the Government's funding need, it is really only a sideshow.