Buoyed by demand, banks want more long-term gilts, but RBI may not yield

Last week, at a meeting with senior officials of the Reserve Bank of India (RBI), participants in the sovereign debt market sought more long-term papers in government bond auctions during the second half of FY23. This is owing to the high demand for such papers.

In market parlance, bonds maturing in 10 years or above are generally referred to as long-tenure securities.

However, the RBI is of the view that states — which could borrow almost double of what they raised in the first half — would also come with long-term papers. This would create a supply glut.

Apart from long-term bonds, the market participants also requested the central bank to reduce issuance of floating-rate bonds and cap sizes of weekly primary auctions to Rs 30,000 crore, said a source.

“Market participants said that the calendar should be in line with the demand-supply in various segments. For example, since there is no demand for the floating-rate bonds, reduce the supply of these bonds,” the person said.

“Since state bond supply hasn’t really been there, there was a demand to issue more long-tenure securities. And lastly, the market requested them not to issue more than Rs 30,000 crore a week,” the person added.

Sources said RBI officials heard out most requests without providing their inputs. However, they were not very comfortable with the idea of issuance of a greater portion of long-term bonds.

The RBI is in charge of managing the borrowings of the central and state governments.

During the current fiscal year, the Centre is scheduled to borrow Rs 14.3 trillion through the issuance of bonds. Of this, around Rs 5.8 trillion is estimated to be issued during October-March.

The RBI generally schedules the borrowing calendar for the second half in late September.

Why more long-term bonds?

According to sources, the market’s request for sale of more long-term bonds was due to firm demand in the first six months, particularly from insurance companies.

From a market point of view, a favourable view on long-term bonds bodes well for trading books. This is because prices of these move sharply relative to minor movements in yields. Bond prices and yields move inversely.

The sharper fall in yields in long-term securities than those on short-term bonds over the last three months reflects stronger demand for the former.

During July-September, yield on the 10-year benchmark government bond has declined 31-basis points (bps). Yield on the liquid five-year paper has fallen 21 bps.

Firm demand from insurers, a sharp decline in crude oil prices and a more benign view on RBI rate hikes have contributed to strong demand for long-term papers.

Short-term bonds, however, have underperformed as yields on these are much more closely aligned with short-term interest rate expectations. And, the RBI is yet to complete its tightening cycle.

RBI officials, however, had their reasons to be circumspect about the idea of more issuance of long-term bonds.

“The only feedback from RBI officials in this meeting was they were not entirely sure that SDL (state development loans) supply for H2 will be as low as it’s been in H1. In absolute terms, it will definitely be higher, but relative to market expectations, will it be lower? They are not sure. So, the RBI is not entirely convinced about the higher issuance of longer-term bonds,” the source said.

Treasury officials expect state borrowings at around Rs 4-5 trillion during October-March against around Rs 2.7 trillion during April-September.

State governments typically borrow more through bonds in the second half of the fiscal year as the Centre slows down the pace of its borrowing during the period. In the current year, states have borrowed a sharply lower amount in the first half than they had announced.

“The request for lower floating rate bonds is an old pain point now. The three floating rate bonds that have been issued over the last 10 months have an outstanding amount of Rs 2.5-3.00 trillion and prices have fallen by around Rs 3,” another source said.

“Banks had put these bonds in the available-for-sale book and that is vulnerable to marked-to-market losses. So, there is no appetite for these bonds. The market has asked for the weekly issuance to come down from Rs 4,000 crore,” he said.

The trajectory of government bond yields is crucially connected to broader borrowing costs in the economy as the pricing of debt issued by other entities, such as banks and corporates, is benchmarked to sovereign debt.

Amid the recent fall in government bond yields, several banks have made a beeline to issue bonds as their access to the capital markets has become cheaper.

WHAT TRANSPIRED AT RBI MEETING

• RBI met market participants, took suggestions on H2 gilt borrowing
• Participants suggested more issuance of long-term bonds
• Banks requested lower floating rate bond issuances
• Market tells RBI to cap size of weekly auctions to Rs 30,000 crore
• Says long-term bonds seeing good demand from insurers
• RBI was not very comfortable with idea of more long-term bonds