Mumbai: The yield on the most-traded nine-year government paper crossed 7% in intraday trade on Thursday, its three-month high, as the bond market grappled with an oversupply of government bonds. Bond dealers now fear that yields will touch and even cross its July 2008 highs of 9.5% in early next fiscal year beginning 1 April, if the government does not sell its bonds directly to the Reserve Bank of India (RBI).
The government is estimated to borrow Rs3.62 trillion next year. It is raising Rs2.6 trillion from the market this year.
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The yield on the nine-year paper rose to 7.17% from its Monday’s close of 6.84% as traders awaited the results of the so-called open market operations by RBI, in which the central bank buys government bonds from the secondary market to create liquidity. The prices and yields of bonds move in opposite directions.
RBI has been buying bonds from the market ahead of its auctions. It will sell Rs12,000 crore worth of bonds on Friday. On Thursday, it bought about Rs7,890 crore in government bonds. It had originally planned to buy up to Rs10,500 crore.
In December, the yield on this paper was seen at 7%. At that time, RBI’s repo rate, or the rate at which it infuses liquidity in the system, was pegged at 7.5% and reverse repo rate, or the rate at which it takes away excess liquidity from banks, at 6%. Now, the repo rate is 5% and reverse repo rate 3.5%. Inflation, too, has come down from 6.5% in December to 2.43% now.
The yield on the nine-year paper had fallen sharply to its all-time low of 4.86% in January, but started rising after the government’s inflated borrowing programme to bridge its widening fiscal deficit.
Banks will not be able to book treasury profits this quarter and may even have to book losses to show their bond holdings at the current market price rather than at the price these bonds were bought.
“I won’t be surprised if the yield touches the July highs or even cross it. These levels are not really attractive. Given the state of the oversupply, we really don’t know where the yields can go,” the head of treasury of a private sector bank said on condition of anonymity.
His views were echoed by another head of treasury of a large Mumbai-based public sector bank who also didn’t want to be named.
“The general feeling in the market is that the (government) borrowing is not going to stop at what the government announced. Pressure on interest rates will continue,” said the public sector bank treasurer, who is also a general manager with the bank.
According to bond dealers, while RBI has addressed the liquidity concern of the market by buying bonds, it has not been able to limit the yields at a particular level.
Though RBI is rejecting bids that demand higher yields in its bond auctions and instead forcing primary dealers, the underwriters of government bond auctions, to buy the unsold stock, the yields are slowly creeping up with every auction, making it costlier for the government to borrow from the market.
In the last two auctions, where RBI sold Rs24,000 crore worth of government papers, primary dealers had to buy at least 12% of the unsold bonds.
Graphics by Paras Jain / Mint