BackBond dealers bet on lower policy rates
Bond dealers expect rate cuts by RBI from March and this should be positive although FIIs may start withdrawing from emerging markets on US recovery
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Mumbai: Calendar 2014 could be better for the bond market as bond dealers are expecting interest rates to fall on softening inflation. Since taking over the reins at the Reserve Bank of India (RBI) in September, governor Raghuram Rajan has raised the key rate twice by a quarter percentage point each before pressing the pause button in December despite rising inflation.
“Inflation is expected to be lower in 2014 and that should help RBI lower rates. Hopefully, 2014 will be a good year for the bond market," said N.S. Venkatesh, head of treasury at IDBI Bank Ltd and chairman of the Fixed Income Money Market and Derivatives Association of India, or FIMMDA.
According to bond dealers, the key factors to look out for in 2014 will be the new government formation and the extent to which the US Federal Reserve makes further cuts in its $85 billion a month asset purchase programme. Already the Fed has announced it will buy $10 billion less every month from January. The pace is expected to increase from the middle of 2014 and interest rates in the US could rise on economic recovery.
Much depends on the new government and its economic policy that will determine the market borrowing size. The fiscal deficit is expected to be under 5% next year and the new government’s economic policies will determine the extent of projected deficit, a key figure that bond dealers will be looking at.
Most bond dealers expect rate cuts by RBI from March and this should be positive for the bond market although foreign investors may start withdrawing from emerging markets on the back of a better US economic recovery. Bond yields could trade between 8-8.25% in the first quarter of 2014, said bond dealers.
Calendar 2013 was not a happy year for the Indian bond market. Suffering from an acute liquidity shortage, short-term treasury bond yields spiked up three percentage points in a fortnight in July as banks rushed to borrow ₹ 2.16 trillion from the central bank—a record for a single day.
Long-term bond yields inched up to a five-year high of 9.25% in August.
The reasons for the sharp movement was RBI’s liquidity tightening measures, taken to rein in a rapidly sliding rupee by cutting speculation.
The domestic currency dropped to its lifetime low of 68.85 a dollar on 28 August, despite a string of measures taken by the central bank to arrest its depreciation. Starting mid-June, RBI restricted banks’ ability to borrow from the central bank and raised the emergency overnight borrowing rate from 8.25% to 10.25%. In mid-July, it further choked the liquidity access of banks.
Secondary market bond yields zoomed but RBI refused to oblige the bond dealers asking for higher rates on fresh bond auctions. By August, the rates on three-month government treasury bills stood at 11.6% and private commercial papers of the same maturity at 12.6%. Companies soon stopped borrowing from the market and rushed to banks to raise working capital loans instead.
Still, the government’s borrowing programme sailed through as RBI agreed to pay higher interest rates to borrow money.
The government plans to borrow ₹ 5.79 trillion from the market in fiscal 2014, out of which ₹ 5 trillion worth of bonds have already been raised.
Until the start of June, though, the bond dealers were a happy lot. The yield on the 10-year bond was at 7.99% and yields were falling. As yields fall, bond prices rise. But after the June measures, yields started rising rapidly, causing massive losses to banks’ investment books. The depreciation losses on banks’ books may have reached ₹ 45,000 crore once the 10-year yield touched 9%, bond dealers estimate. “The major take of 2013 was that we need to be cautious. The bond market in India usually rides on an expectation that a bull run continues for long and the correction is slow. However, measures taken in June and July really broke the market," said S. Srinivasa Raghavan, head of treasury at Dhanlaxmi Bank Ltd.
“Except for a handful of banks, everyone suffered heavy losses because of the monetary tightening," he said, adding that the Reserve Bank helped banks by relaxing bond holding norms that minimized depreciation losses.
Owing to the mounting losses at banks, RBI allowed banks to shift their trading portfolio to held-to-maturity (HTM) portfolio, where there’s no depreciation loss.
However, bond dealers are still wary of the market, as is evident from the thinning trade volume. The volume on the RBI’s bond trading platform averaged about ₹ 40,000 crore in May, even crossing the ₹ 60,000 crore mark, but in December it fell to a mere ₹ 5-6,000 crore.
To be sure, part of the reason could be the year closure, but typically in the last week of December, foreign banks are heavy buyers of government bonds. This year, the banks were largely absent.
Foreign institutional investors (FIIs), too, were net sellers in the Indian debt market. Net of purchase, FIIs sold $8.02 billion in debt in calendar 2013, compared with $6.9 billion of net buying in the previous year.
“Overall, the market is very dull, very cautious. Investors are saving the bottom line amid uncertainties," Raghavan said.
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