India’s bond market is seeing a strange phenomenon. Traders are no longer trading on the benchmark 10-year bond, preferring instead to take positions on the five-year and six-year securities.
There were days in the past two weeks when there was no trading in the 10-year paper. In the last few days, it is being traded at a very thin volume. In normal times, it is always the highest traded security.
A debt fund manager said that with the debt market fragmented among so many securities, he was afraid to take positions because he was worried about the illiquidity of the paper he was investing in.
The yield on the 10-year government paper is often taken as the long-term interest rate prevailing in the economy.
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So important is the bond that the regulators have allowed trading on interest rate futures on Wednesday, with the 10-year paper as the benchmark.
Banks even calculate their mark-to-market losses taking the yield of this paper as the benchmark. Yet, even as headline inflation dipped to negative territory, trade in the 10-year paper was very thin.
Why are traders treating the 10-year paper as a pariah, with long-term investors such as insurance companies and banks shifting this paper to their held-to-maturity category and sitting pretty on it, even as this paper was introduced very recently?
The answer lies in the massive issuance of this paper in a short span of time. Since its introduction in February, the government has already introduced Rs53,000 crore worth of this bond.
Another Rs7,000 crore and the security could easily become the paper with the highest-ever amount issued against it. It will probably not happen because at redemption, the government has to cough up a massive amount of money at one go.
The life of a benchmark paper could be astonishingly short. The last two popular benchmark papers, 8.24% and 7.46%, are no longer traded in the market and are illiquid now.
What will probably happen is that the government will come out with another 10-year paper and make this one obsolete. Or, it can re-issue a paper maturing at the same time as the current one and signal the market to crown it the new king.
These are precisely the two possibilities traders are dreading. The amount outstanding on the 6.35%, 2020 paper is only Rs16,000 crore, giving ample room for the government to re-issue it further and make it the new benchmark.
In fact, dealers have already started trading on this paper expecting that this could become the next benchmark.
In the absence of any signal from the Reserve Bank of India (RBI) about the benchmark, traders are finding it prudent to stay away from trading in the 10-year segment. But the fragmentation of the bond market unnerves investors and raises questions about the RBI’s debt management tactics.
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