Mumbai: Trading volumes in the government bond market are thinning as public sector banks have sold bonds on worries that rising yields may force them to make higher provisions to cover losses on their gilt portfolio, said bankers and dealers. This may, however, force the government to shell out higher rates when it resumes market borrowing in April.
Since the start of 2018 till Wednesday, public sector banks are net sellers of government bonds in 31 out of 49 trading sessions, according to Bloomberg data.
In February, the daily average number of trades across government bonds, state development loans and treasury bills, fell to 2,886 from 3,423 a month ago, according to data from the Clearing Corp. of India Ltd.
Average daily traded value also fell to Rs25,955 crore in February from Rs31,510 crore a month ago. Traded value had fallen on month-on-month basis in January and December.
The benchmark 10-year bond yield was trading at 7.666% as against 7.685% on Wednesday. It has risen 120 basis points since the start of 2 August 2017, when the Reserve Bank of India (RBI) had last cut interest rate.
“Worries of a rate hike due to rising inflation led to a rise in yields. But the current rise is on account of factors such as rising yields globally and strengthening of the dollar," said Soumyajit Niyogi, associate director at credit rating agency India Ratings,
He added that the recent inflation numbers does not materially change the view of interest rates. However, it may alleviate some concerns of rate hike and lead to a pro-longed pause.
Data released Monday showed retail inflation surprisingly slowed for the second consecutive month to 4.4% in February from 5.1% in January.
According to bank treasury officials, with expectation of a rise in interest rate, it is usual for bond yields to rise and, subsequently, lead to a drop in trading volume. However, this time around, there is no buying support from government-owned banks, which have a large share and play a crucial role in providing liquidity in bond markets.
“With the rise in yields, nobody wants to buy for investments because of fears of MTM (mark-to-market) provisioning, especially when profitability is already under pressure because of asset quality pain. Moreover, there is not going to be any dispensation from RBI to deal with bond losses. This has impacted more than anything else," said an official of a public sector bank, requesting not to be named.
Banks have to mandatorily invest a portion of their deposits in government securities as statutory liquidity ratio (SLR). It currently stands at 19.5%. However, the banking system’s SLR level at least 10% higher than the regulatory requirement, said bond dealers.
Addressing dealers on 15 January, RBI deputy governor Viral Acharya criticized banks for seeking the regulatory dispensation in managing interest rate risks and had said that granting such leeway was not desirable from the point of view of efficient price discovery in the market.
Acharya’s speech came after banks requested RBI to let them spread the MTM provisioning, for covering losses on bond portfolio, over few quarters.
Banks have to revalue their bond portfolio at the end of every quarter. In case the value of the securities is lower than the market rate, they are mandated to keep aside funds as mark-to-market provisioning.
In the December quarter, the yield on 10-year benchmark government security rose by around 66 basis points mainly because of worries that the government may not meet its fiscal deficit target, which eventually turned out to be true.
For instance, State Bank of India had provided Rs3,400 crore for MTM losses in fiscal third quarter.
India Ratings’ Niyogi said that with easing liquidity conditions—as treasury bills worth Rs1 trillion issued under Market Stabilisation Scheme mature this week—there could be some buying support from banks.
Bond dealers said with improvement in liquidity conditions from April, the weekly auctions of government bonds in the primary market may sail through but at a higher yield as the view on interest rates remains unfavourable. This may stretch the fiscal position of the government.
For the next fiscal, the government’s gross borrowing stands at Rs6.06 trillion. It is yet to reveal its weekly borrowing schedule.
“There is a need to create new demand avenues and one of the ways of doing is to increase the limit for FPIs (foreign portfolio investors) to buy government bonds. I think, at the current level of yield, there is likely to be good demand from FPIs," said Ashutosh Khajuria, executive director and chief financial officer at Federal Bank.
Currently, FPIs have exhausted 99.57% of the available limit for investing in Indian government bonds. This is essentially for FPIs under open category, which are most active.