Indian bonds rally after RBI allows banks to spread debt losses

India’s sovereign bonds rallied after the central bank allowed lenders to spread out trading losses, a second policy decision in two weeks to revive a debt market that had sold off for seven months.

The Reserve Bank of India said late Monday banks can account for their bond-trading losses, incurred in the past six months, over as long as four quarters. The move will help bring state-run lenders -- the biggest holders of debt -- back to the market, said Dhawal Dalal, chief investment officer for debt at Edelweiss Asset Management Ltd.

Government banks were staring at a potential mark-to-market loss of 200 billion rupees ($3 billion) in the March quarter, three times more than in the period to December, according to a Credit Suisse Group AG report last month. Hit by the erosion, lenders have remained on the sidelines, contributing to the deepest rout in two decades in the nation’s sovereign bonds.

“The recent set of news are positive for the market and suggest that the authorities are getting proactive in their approach,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. The rout was “largely a supply-demand issue. This balance is getting resolved slowly and this should push yields lower with time.”

The reprieve came days after the government surprised traders by reducing the fiscal first-half borrowing, a move that spurred the first monthly advance since July. With the reduction in debt supply, traders have been expecting the government to do more to spur demand.

Spike Guard

The benchmark 10-year bond yield declined seven basis points to close at 7.33 percent in Mumbai. The rupee strengthened 0.3 percent to 65.0112 per dollar, ending two days of retreat, while bank stocks advanced.

There is a precedent for the central bank’s action. The RBI in 2013 allowed banks to spread their bond-trading losses as the benchmark yield surpassed 9 percent and the rupee fell to a record amid the taper tantrum selloff. This time, the authority has also asked lenders to set up a so-called Investment Fluctuation Reserve to guard against yield spikes in the future.

Three other factors are driving the shift in sentiment:

Sovereign debt worth 700 billion rupees mature in April. The cash returned would be the most in a single month for the new fiscal year, according to central bank data.

The RBI may sound less hawkish at its policy review this week as it holds the key policy rate at 6 percent, according to all 26 economists surveyed by Bloomberg.

The RBI is also mulling a higher quota for foreigners, which is currently capped at 5 percent of the total outstanding. Every single percentage point increase may lure as much as 850 billion rupees of inflow, according to DBS Bank Ltd.

Yield on the 10-year bonds slid 33 basis points in March to end at 7.4 percent. Indian financial markets were closed Thursday, Friday and Monday.

“I’m not expecting the RBI to be as hawkish as they were in the previous policy meeting,” said Harish Agarwal, a fixed-income trader at FirstRand in Mumbai. “The rally has more legs.”