Watching the daily trade movement of government bonds at the national depository system order matching screen, a platform developed by the Clearing Corp. of India Ltd, India’s bond trading exchange, Aloke Prasad cannot hide his disappointment.
“There is hardly any volume,” says the assistant general manager with Securities Trading Corp. of India Ltd (STCI). “Barely Rs2,500 crore of securities have been traded today. There is not much movement in the yield of securities. The bond market is inactive and there is no trigger at this point to make it lively.”
Until recently, Prasad was with the bond-dealing wing of STCI, a primary dealer that buys and sells government bonds. He is now associated with non-banking finance wing of STCI that deals with equities and other investments. The yield and price of bonds move in opposite directions.
The platform is a relatively new online offering, having been launched in 2005. Only banks, primary dealers, insurance companies, mutual funds and foreign institutional investors (FIIs) are allowed to trade on it.
Early this century, the bond market was booming in India while the stock market was range-bound. As the economy was experiencing a slowdown, corporations were not lifting money from banks. As there was no credit growth, banks were heavily investing in government bonds.
Under the Indian banking law, banks need to invest 25% of their deposits in government securities. However, they actually invested more than 40% of their deposits in bonds. The surfeit of liquidity brought down the yield of bonds, pushing up prices and bond dealers made money with both hands.
The scenario has changed dramatically with banks starting to lift credit and interest rates going up. Over the last few months, the yield on the 10-year benchmark bond is range-bound between 7.80% and 7.90%, after rising to 8.4% in June. The daily trade volume has gone down to around Rs3,000 crore, almost one-fourth of the trading volume in 2003 when the 10-year paper yield touched its all-time low of 4.97%.
Another contributing factor to the stagnancy in the bond market is the government’s market stabilization scheme (MSS).
Under this scheme, which was introduced in 2004, the government started floating bonds outside its annual borrowing programme to soak excess liquidity from the system that is generated by the continuous Reserve Bank of India’s (RBI) intervention in the foreign exchange market.
RBI is buying dollars from the market to rein in the runaway appreciation of the rupee as a stronger rupee hurts exporters since their dollar income on rupee term goes down. With every dollar RBI buys from the market, an equivalent amount of rupees flows into the system, and bonds under MSS drain that excess liquidity.
“Earlier it used to be in short-term treasury bills, but we saw a lot of MSS coming in the form of dated securities. The supply has, in fact, outpaced the demand,” says A. Prasanna, vice-president, ICICI Securities Primary Dealership Ltd. So, banks are not chasing the government bonds any more. “As far as policy rates are concerned, we have reached some sort of equilibrium right now. I see the bond market remaining range-bound.”
Bond dealers can make money if there is volatility in the market. With no change in the policy rates, bond yields have remained range-bound. The absence of good market makers also contributed to this. Public sector banks are the major players in the market, but they do not have too many experienced treasury managers because of the transfer policy.
“One starts picking up the tricks of the trade and gets active, but soon he is transferred. Unless the transfer policy is changed, there won’t be too many seasoned treasury mangers from the state run banks who can play the role of market makers,” says a senior official of a large public sector bank, who does not wish to be identified.
Another contributing factor is the lack of short-selling instruments in the bond market. Traders in the bond market can short sell, but until recently they had to cover it on the same day.
Recently, RBI allowed banks and primary dealers to short sell 5% of their holdings in government bonds, but the bond sold has to be bought back on the fifth day.
Finally, foreign participation in bond market is also small compared with their play in the equity market. FIIs’ exposure to bond market is capped at $3.2 billion. In contrast, more than $17.5 billion worth of FII funds flowed into the Indian equity market since the beginning of 2007.
Ashish Ghiya, managing director of Derivium Capital & Securities Pvt. Ltd, a debt brokerage, wants the government to open up the debt market the same way it did for the equities. “Equity markets were allowed to open up; foreign participants were welcomed and tax laws were changed. Whatever infrastructure government has allowed for equities, it can do the same for debt market as well,” Ghiya says.
R.H. Patil, Clearing Corp. chairperson, does not agree. “RBI has allowed short selling, it has also taken several steps for the bond market. What else it can do? After all, it all depends on the economic condition. You should not engineer volatility,” Patil says.
Prasanna says that bond market will receive a fillip if bond futures are introduced.