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MUMBAI : An unlikely rally in government bonds has spurred hopes for a bumper September quarter for banks.

Banks, which had taken a sharp hit because of mark-to-market losses on their investments in government securities in the June quarter, will be able to write back some of their losses if the yield on the 10-year government bond continues around the current level till the end of the month.

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The benchmark 10-year government bond closed at 7.45% at the end of June, but has since fallen to 7.22% as of Thursday. This comes despite a 50 basis points rate hike by the Reserve Bank of India in July and August, and consumer price inflation touching 7% in August.

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Last week, the 10-year yield fell to its lowest level of 7.08% since 25 April following news that JP Morgan was in talks with major investors to include India in the GBI-EM Global Diversified Index. Separately, the fall in crude price below $90 a barrel also helped support bond prices. There is an inverse relationship between the yield and the price of a bond, which means that yields fall as bond prices go up and vice versa.

With 15 days remaining for the close of the second quarter, bankers expect yields to be capped at 7.3% at the end of September after considering the potential rate hike by the Reserve Bank of India’s rate-setting panel this month.

“Yields have come down despite the inflation numbers. Yields should have spiked. Instead, it has come down by 5-6 bps. All banks have provided heavily in the June quarter at 7.45%. Today, the yield is around 7.17% levels. If it continues like this till 30 September, there will be a good amount of write-back for banks, which will add to the profits," said Soma Sankara Prasad, managing director and chief executive of UCO Bank.

Rising bond yields had impacted the operating profit of most banks, including HDFC Bank, Axis Bank, Kotak Mahindra Bank and State Bank of India.

The repo rate hike of 90 basis points in May and June, followed by other measures aimed at squeezing liquidity, had led to a sharp rise in yields during the June quarter. In the three months to 30 June, the benchmark 10-year government bond yield rose by 59 basis points to 7.45%.

Banks are required to mark securities to their prices on a substantial portion of their bond portfolio in the available-for-sale (AFS) and held-for-trading (HFT) books every quarter to account for changes in the prices of their bond holdings.

“The Indian bond market has decoupled from the US bond market of late due to lower crude prices and news of inclusion in Global Bond Index. If crude prices and USD-INR remain favourable, banks treasuries are hopeful of showing profit and provision write back this quarter," said Gopal Tripathi, treasury head, Jana Small Finance Bank.

Bankers are pencilling in a 35-50 basis points rate hike at the end of this month, taking the policy rate to 5.9%.

However, they believe that RBI would tread cautiously not to upset the growth momentum.

The economy grew 13.5% in the June quarter, slower than RBI’s estimate of 16.2%.

Bank credit growth, however, has been robust at 15.5% over the last two fortnights from a year earlier, supporting banks’ profitability.

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