A day after the first-step of a two-step increase in the reserves banks need to maintain with the central bank came into effect, and drained around Rs8,000 crore of liquidity from the banking system, the government bond market was virtually unmoved. And the spread between corporate and government bonds has been increasing. Last week, the Reserve Bank of India raised the cash reserve ratio to 6% in two steps, from 5.5% to 5.75% on 17 February and then, from 5.75% to 6% on 3 March.
The yield on the five-year corporate benchmark bond moved up sharply on Monday to close at 9.45%, registering a 30 basis points rise over its last close. With this, the spread between the five-year government paper and corporate paper of identical-maturity has substantially widened in the last five months.
According to estimates by bond traders, Indian companies issued Rs4,750-cr worth of bonds in October and November 2006, but between 1 January and now in 2007, they have issued only Rs900 crore .
The 10-year benchmark government bond yield closed at 8.02%, unchanged from its previous week’s close. Bond traders said the government bond market did not feel the pinch of the hike in cash reserve ratio because of the central bank’s intervention in the foreign exchange market. “The effect of the hike in cash reserve has been largely neutralized by the central bank’s intervention in the foreign exchange market. It is buying dollars and released money into the system and sucking out the same money by raising the reserve ratio,” said a bond dealer. RBI is buying dollars to prevent any sharp appreciation of the rupee that will hurt exporters.
The spread between the corporate bond AAA rated paper (indicating that it was very safe) and government securities,which was about 100 basis points five months back, is now 150 basis points.
This is because, banks, primary dealers and mutual funds have largely kept away from the corporate bond market. Though traders believe there is nothing wrong with the quality of such corporate papers, there is little chance of the spreads narrowing. “Banks and dealers have moved away from the corporate bond market due to concerns over the overall monetary tightening policy by RBI,” said Partha Mukherjee, head of treasury operations at UTI Bank.
The corporate bond market now has only two major buyers, Life Insurance Corporation and the Employees’ Provident Fund Organization. Commercial banks, primary dealers and mutual funds have moved to trading in oil bonds and food bonds, as they are identical to government securities in their character.
Mukherjee, however, does not agree with this trend. “Oil or food bonds cannot be called substitutes for the highest rated (AAA) papers,” he said.
According to bond dealers, the corporate bond market needs depth and this can only happen with the introduction of hedging instruments like credit derivatives and interest rate futures. The entry of long-term players like pension funds—as and when they are allowed—will change the rules of this market.
“Banks prefer syndicated loans rather than trading in the corporate bond market. The hike in cash reserve has caused a lot of volatility . When more long-term participants appear and credit growth slows, there will be a narrowing of spread between corporate bonds and government securities,” said Sundeep Bhandari, managing director, head, global markets, South Asia, Standard Chartered.