Succour or slap? India’s bond market needs a bit of both
The yield on the new benchmark 10-year government bond jumped 11 basis points on Tuesday, to 7.38%
India’s banks were hoping the regulator would feel the pain of their bond-market losses and maybe offer a palliative. What they got instead from the Reserve Bank of India (RBI) was tough love. Condemnation by deputy governor Viral Acharya may be correct, but it won’t resolve the mess.
In a speech in Mumbai on Monday, Acharya revisited the nexus between the government and banks, a topic close to his heart even when he was a New York University professor and an adviser to the European Systemic Risk Board. Then, most of his criticism was directed at “myopic governments” leaning on domestic banks as a low-cost funding option for their deficits. Now, he’s pointing the sharp end of his stick at the lenders themselves:
It appears that for most banks investment activity essentially consists of two steps—buying and hoping for the best. But hope should not be a treasury desk’s primary trading strategy.
Since the lenders were hoping to get the RBI’s nod to spread the mark-to-market losses on their bond portfolios over a few quarters, the rebuke sent them sulking.
The yield on the new benchmark 10-year government bond jumped 11 basis points on Tuesday, to 7.38%. It’s on course to climb for a sixth straight month amid faltering revenue from the goods and services tax (GST) and an increase in New Delhi’s borrowing program . It was only when India said Wednesday that it would slash planned additional borrowing by 60% to $3.1 billion that the market heaved a sigh of relief.
Still, edginess lingers. Rising global oil prices are a worry. As the government hesitates to pass on the extra burden to consumers, it may have to cut fuel taxes to keep pump prices stable.
So much for supply. What about demand for bonds? Acharya rightly chastised banks, the dominant players in the marketplace, for not managing their interest-rate risk more proactively. State-run lenders, which control 71% of the country’s banking assets, may be powerless to influence New Delhi’s choice of issuance: The average maturity of bonds sold during the last five years has been as high as around 15 years; the longer the duration, the higher the risk of a loss for the buyer.
The banks could have exercised better control over their balance sheets, however. As the deputy governor pointed out, there’s no reason why state-run institutions, which account for one-third of trading in government securities, should have a less than 5% share of hedging via interest-rate swaps.
That laziness aside, the main problem, as I noted earlier this month, was the $200 billion in excess holdings of government bonds beyond what the banks are asked to keep as “statutory liquidity,” according to Bloomberg Economics’ calculations. This portion, which must be marked to market, ballooned only after Prime Minister Narendra Modi outlawed 86% of the country’s cash in November 2016, sending people scurrying to deposit accounts.
Then the RBI ignored the deflationary impact of that note ban by not cutting interest rates as sharply as it should have. Amid weak demand for bank loans, the lenders’ search for yield sent them to government bonds.
If the RBI is now frustrated with the state-run banks for having loved sovereign debt a bit too much last year, it also must accept some blame. The multiple hats it wears—of monetary authority, bank regulator and the government’s investment banker—are bound to make the head a little hot at times.
And this is one of those times. As many as 11 of India’s 21 publicly traded state-run banks are currently under their regulator’s so-called “prompt corrective action” regime, having racked up huge bad loans on corporate advances. If they can’t even get a little leeway in accounting for their bond-market losses, how will they exit the doghouse?
Even that redemption is to be made possible by a special capital injection. And the government wants to finance it partly by ... selling the banks some more bonds. If the current sour sentiment in the market persists, good luck with that.
It’s a vicious cycle of mutual dependency. And while Acharya is perfectly right about the need to break it, the real solution lies in hacking away at the government’s stifling presence in banking. Address that first, and everything else falls into place. Until then, the regulator can admonish the banks all it wants—but it can’t deny them succor when they come running. Bloomberg Gadfly
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