Mumbai: A few months after the liquidity crisis erupted in September, mutual funds switched a chunk of their sovereign bond holdings from central government securities to state development loans (SDLs), showed data from the Reserve Bank of India (RBI).
According to the data, mutual funds held ₹36,851 crore worth government securities (G-Sec) in December 2018, against ₹78,999 crore in September 2018, and ₹70,241 crore in December 2017. Out of the entire pool of government bonds, MFs owned 0.64% in December 2018, down from 1.41% three months ago. This data is typically released with a lag of four months. The December data is the latest available so far.
Following a series of defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS) last year, mutual funds with exposure to debt papers of the company had to write off a chunk of their holdings. This, and the ensuing defaults by some non-banking financial companies (NBFCs), had led to the liquidity crisis.
Interestingly, in the same period, mutual funds bought SDLs issued by state governments. They increased their holding in SDLs to ₹32,833 crore in December 2018, from ₹26,951 crore in September 2018. Of the total base of SDLs, mutual funds had a share of 1.23% in December, against 1.05% in September.
States raise money from the market through SDLs, which are dated securities issued through auctions similar to those conducted for those issued by the central government. Interest on SDLs is paid every six months and the principal is repaid on the maturity date. SDLs are backed by the sovereign and acknowledge the government’s debt obligation.
According to a treasurer at a mid-sized public sector bank, G-sec yields dropped in the last quarter of 2018, and liquidated some of their holdings. Bond yields and prices move in opposite directions. “The spread between the G-sec and SDLs is typically 50-100 basis points (bps), and while SDLs are not very liquid compared to G-secs, they have the same sovereign backing," the banker said, asking not to be identified.
The yield on the 10-year G-sec fell to 7.283% on 31 December, from 8.024% on 29 September.
R. Sivakumar, head-fixed income, Axis Mutual Fund said the switch to SDLs may also indicate the flow of funds favouring it.
The central bank’s holding of G-secs rose 205 bps between September and December 2018, as it conducted open market operations (OMO) to infuse liquidity. In December alone, the RBI had announced OMOs of ₹50,000 crore.
Lakshmi Iyer, chief investment officer (debt) and head (products), Kotak AMC, attributed the uncertainty on the fiscal front to mutual funds reducing exposure to government securities. “Given that there is a question mark over the pace and quantum of OMOs, one is not sure of the demand levers. Besides, the FPI continues to be net negative sales in debt."
Iyer added that until clarity emerges on the fiscal front, this situation may continue. “The market also needs clarity on the political outcome, which is a month away. Hence, near-term uncertainty may not abate anytime soon."
Others said that if inflation measured on the consumer price index (CPI) pans out as per the RBI’s projections, room for further easing of monetary policy and liquidity should open up.
Murthy Nagarajan, head, fixed income, Tata Mutual Fund, said that supply of state government papers is the highest in the third and fourth quarter of the financial year.
“The supply tapers off in the first and second quarter of the financial year. The spread between government securities and state government papers tends to widen in the third and fourth quarter, and comes down when supply reduces in the first and second quarter," said Nagarajan.
Meanwhile, the central bank announced on Tuesday that it will inject ₹25,000-crore liquidity through open market operations (OMOs) in May. The RBI also conducted its second successful dollar swap auction of $5 billion, receiving bids worth $18.65 billion, or more than three times what was on offer, besides injecting ₹34,874 crore liquidity into the system.
To be sure, debt mutual funds witnessed outflows last December. Data from industry body, Association of Mutual Funds in India (Amfi), showed that there was a net outflow of ₹3,387.5 crore in debt mutual funds in December 2018, while there was a net inflow of ₹12,939.70 crore in March.