Banks are going slow in purchasing bonds ahead of the Union Budget

Banks are going slow in purchasing bonds ahead of the Budget as there is no certainty about the borrowing programme that may come in February. 

The market at present expects the borrowing programme to be Rs 6-6.6 trillion on a gross basis, higher by about Rs 500 billion from last year. Normally, the rise should have been okay for the market, but there is a qualitative difference this time. There is a marked loss of appetite for the papers this time.

This is because there is no certainty that foreign investors would be able to buy as much as they did in the present fiscal year because they have already exhausted their limits and the incremental opening up in the space is very limited. In the current fiscal so far, foreign investors have poured in $19.19 billion in domestic debt segment, almost exhausting their limits in both government and corporate bonds. 

Besides, rising crude oil prices, and a possibility of rates hardening in the next fiscal year due to a hawkish central bank stance would be detrimental to bond yields.

When yields rise, bond prices fall. And banks have to book mark-to-market losses on their trading portfolio if prices drop below their historical price at which they were purchased.

Banks in the December quarter may have booked at least Rs 150 billion in mark-to-market losses. The Reserve Bank of India (RBI) has clarified that it won’t be interested in giving any relaxations to banks on these losses. Therefore, the appetite for investing in bonds at a time prices are expected to fall won’t be much for banks. 

Bankers say till the Budget numbers are clear, they wouldn’t like to take much of an exposure in bonds. Of course, public sector lenders are not free to choose in the truest sense. They do bid in bond auctions, but at prices that are unacceptable to the central bank.

For example, after cancelling the auction of Rs 110 billion worth of bonds in end-December, the RBI again had to cancel the auction of Rs 40 billion in ultra-long tenure papers. While the central bank received more than Rs 100 billion of bids for the bonds maturing in 2034 and 2046, it did not sell any. The remaining Rs 110 billion worth of bonds were sold off easily.

The reason is not given, but it is not hard to understand that banks had demanded much lower price (and therefore higher yields) for these semi-illiquid ultra-long papers, which was not acceptable to the RBI.

“It is true that the appetite for bonds is dipping among public sector banks,” said Devendra Dash, head (asset liability management), AU Small Finance Bank.

“Even if fiscal deficit is contained at 3.2 per cent (of gross domestic product or GDP), the supply will be enormous and there will be a substantial demand-supply mismatch. The banks don’t have space to absorb those because of a cut in SLR (statutory liquidity ratio, or the mandatory bond holding limit), as also the fear of rising yields is always there,” Dash said. 

One issue that banks are not appreciating at this current juncture is the flip-flops the central government did in its borrowing assessment. 

In late November and even in the first week of December, government officials said they won’t require extra borrowing, but then announced Rs 500 billion worth of extra borrowing. The amount was again cut to Rs 200 billion by early January. Now, Prime Minister Narendra Modi has hinted that the Budget won’t be a populist. This has given comfort to the market, but still, they would want to see the numbers before deciding on their bond strategy, bankers say.

The market, though, is confident that the government has enough avenues to manage its finances. Even as it could not garner extra dividend from the RBI, about Rs 350 billion was managed through the merger of Oil and Natural Gas Corporation and Hindustan Petroleum Corporation.

“The incidents have demonstrated the credibility of the government and the RBI. The government managed to show broad-based sources of revenues when the transfer of surplus was almost halved from the RBI. On the other hand, the RBI, too, has demonstrated its independence by transferring much lower than the budgeted amount,” said Soumyajit Niyogi, associate director at India Ratings and Research. 

India Ratings expects the borrowing programme on a gross basis at Rs 6.6 trillion, while it said the 10-year bond yields could be at 7.50-7.60 per cent by the end of FY19.

The 10-year bond yields closed at 7.25 per cent on Tuesday, slightly lower than on Monday.

A SNAPSHOT
 

• Market expects borrowing programme to be Rs 6-6.6 trillion on gross basis, higher by Rs 500 billion from last year
• In current fiscal, foreign investors have poured in $19.19 billion in domestic debt segment, almost exhausting their limits in both government and corporate bonds
• Rising crude prices,and possibility of rates hardening in next fiscal would be detrimental to bond yields