Mumbai: In the first bond auction of the fiscal year, the central bank failed to sell a sizeable 9% of the benchmark 10-year paper on offer. Investors sought a higher cut-off yield for the bonds, and primary dealers—underwriters for government bond auctions—had to buy Rs450 crore of the Rs5,000 crore issue.
The other two bonds on auction—Rs5,000 crore of two-year paper and Rs2,000 crore of 17-year debt—were fully subscribed and performed better than expected.
The devolvement of the 10-year bond pushed yields to cross 8% for the first time in a month. On Thursday, the yield on the 10-year bond was at 7.75%, but started rising after the government said food price inflation rose at a higher-than-expected 17.70% in the year ended March. The faster inflation means the Reserve Bank of India (RBI) may have to tighten policy rates at a sharper pace than was anticipated.
Until Thursday morning, investors had anticipated a 0.25 percentage point hike in RBI’s policy rates, but the possibility of a 0.50 percentage point increase following the food inflation figures spooked the bond market, pushing yields higher. RBI’s next monetary review is scheduled for April 20. In a rising interest rate scenario, holding a long-tenure bond becomes risky as yields rise —or prices fall—with every rate hike, pushing older purchases into a loss from a trading point of view.
The 10-year bond is considered the most important in this regard as banks benchmark their investments to this paper.
The cut-off yield for the 10-year paper in the Friday auction came at 7.9645%, against the market expectation of 7.90%, as per Bloomberg estimates. The yield closed at a little more than 8% on Friday. “The devolvement shows the bearishness in the market,” said G.A. Tadas, MD of IDBI Gilts Ltd, a primary dealer.
Arvind Sampath, director, rates, at Standard Chartered Bank, said the devolvement could have happened because of the nervousness in the market ahead of a large borrowing programme. “Nobody wants to be the first buyer when the auction calendar is so huge. The waiting phenomenon is behind the spike in yields,” said Sampath. “Policy rates are far lower than the market yields, and bond yields have factored in a rate hike in April... It’s true that the bond yields may move up to 8.25-8.30% in two months, but we may not see this kind of sharp movement.”
Bond dealers say managing the government’s Rs4.57 trillion borrowing programme in fiscal 2011 will be a huge challenge for RBI as it doesn’t have the tools it had last year, such as the unwinding of Rs88,000 crore of intervention bonds or the leveraging of its balance sheet to buy back Rs56,000 crore of bonds from the secondary market.
But dealers consider the present yields attractive for banks as the lenders can buy these bonds in large numbers instead of parking surplus money in excess of Rs1 trillion with RBI and earning only 3.5% interest. The cut-off yields on the two-year paper came at 5.9803% and the 17-year paper at 8.2908%, against Bloomberg’s estimates of 6.09% and 8.32%, respectively.