Mumbai: Trading volume in the bond market has fallen to less than half the January level as government debt sales amounting to Rs12,000 crore a week and falling bond prices deter investors from buying existing securities.
The average daily trading volume fell to Rs6,156.42 crore in the seven trading sessions between 10 August and 18 August, from Rs13,433.27 crore at the start of this year.
The government needs to borrow Rs4.51 trillion from the market in the fiscal year to March, of which it has already borrowed Rs2.17 trillion, to plug a fiscal deficit equivalent to 6.8% of gross domestic product. Every week, the government is borrowing Rs12,000 crore from the market, with the next auction due on Friday, according to the bond-sale calendar.
“Investor demand in the bond market has waned in the previous weeks due to the weekly supply calendar,” said Arvind Sampath, head of rates trading at Standard Chartered Bank. “Volumes in the secondary market have dwindled as prices have steadily declined, whereas supply continues unabated.”
Ten-year government bond yields held near a nine-month high of 7.18% on Thursday, from 7.16% on Tuesday. The bond market was closed on Wednesday. Bond yields and prices move in opposite direction.
The rising yields could mean higher borrowing costs for companies. That comes on top of concerns that the private sector would be crowded out this year by the heavy government borrowing.
The government had targeted borrowing Rs2.41 trillion in the first half ending 30 September, of which it has already borrowed Rs2.17 trillion.
Banks, the biggest investors in government securities, are staying away from the secondary market on concerns about piling up losses in their bond portfolio, bond dealers said.
As bond yields rise and prices drop, banks incur losses on their bond holdings and would have to sell the securities at a price lower than what they paid.
Even if they don’t sell the bonds, banks would have to set aside money to cover the price erosion, which dents their profitability. Banks are instead preferring to buy new bonds at central bank auctions and keep them in the so-called held-to-maturity (HTM) category, which they would hold until maturity when the government buys them back.
“The purchase is happening in the primary market and any incremental buying is shifting to the HTM category, wherever there is room for it,” said Mohan Shenoy, head of treasury at Kotak Mahindra Bank Ltd.
Banks are required to invest at least 24% of their deposits in government securities. Banks’ investments in such securities have risen to more than 27%, higher than the minimum requirement. Public sector banks may not have much room to accommodate bonds in the HTM category, keeping them away from primary market auctions too, according to a 17 August story published in Business Standard.
With every passing auction, market participants are demanding higher yields from the government. The Reserve Bank of India (RBI) had to cancel one auction last week because dealers wanted higher yields than the government was willing to offer, according to bond dealers.
The Reserve Bank of India didn’t explain why the auction was cancelled.
The rise in yields is also bad news for companies, which would have to pay more when they borrow from the market in the second half of the year.
The government wants to borrow most of its needs in the first half, leaving space for companies to sell debt in the second.
Sensing higher borrowing costs ahead, companies such as Larsen and Toubro Finance Ltd and Tata Capital Ltd, have already started tapping the bond market.
“No matter what people say, the obvious outcome of a higher government borrowing is crowding out (of) private investment demand,” said Prabal Banerji, group chief financial officer of the Hinduja group. “When you have a government borrower and a private borrower, people will obviously put a premium on the private borrower over the government borrower. Accessing the bond market in the next six to nine months will be very difficult for companies.”
Indian bonds will decline further as faster industrial growth boosts demand for loans, leaving banks with less money to buy debt, according to HSBC Holdings Plc. Industrial production rose 7.8% in June, the most in 16 months.
Bond market participants are expecting a turnaround in sentiment starting October,
“October onwards, supply of bonds will come down. Hopefully the market will revive after that,” said A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd.
Sampath of Standard Chartered says the government’s borrowing schedule could be tweaked to spread out the supply of new bonds to revive investor appetite.
“Further, government balances appear comfortable, allowing the luxury of spacing out borrowing over the next few months instead of the current bunched-up schedule,” Sampath added.
Bloomberg contributed to this story.