Demand for long-term bonds likely to taper on weak insurer interest

Long-term government bonds might bear the brunt of declining demand from insurance companies, and the prices of these papers could fall, according to dealers. Typically, insurance companies invest in long-term papers that suit their asset-liability management needs.

Bond prices and yields move inversely.

In the Union Budget for FY24, the government proposed to tax income from high-value life insurance policies, other than unit-linked insurance plans. Tax was imposed on life insurance policies with annual premium exceeding Rs 5 lakh per year. The tax regime was effective from April 1, 2023.

As a result, there was heavy buying of such policies in February and March, before the new tax regime kicked in. Insurers deployed the funds in April and May, dealers said. “There was pent-up demand in April and May because they (insurance companies) received a large amount of funds in March which they parked in April and May,” a dealer at a state-owned bank said.

Dealers expect the long-term bond supply pressure to play out which would further weigh on long-term bonds’ prices. “The Q2 of every financial year is very bearish due to supply pressure, but this time lack of demand from insurers preponed the event by 10-15 days to the first quarter,” a dealer at a state-owned bank said.

The increase in bond issuances is negatively affecting the long-term prices of government bonds. According to the government’s borrowing plan for April to September, the government intends to sell government securities worth Rs 1.69 trillion in June. This issuance is the biggest monthly offering in 2023-24, thus far.

Also, private insurers are opting to invest in state-government securities rather than Government of India securities due to higher returns on long-term state bonds, dealers said.

The Reserve Bank of India set the cut-off on the 10-year state bonds at 7.39 per cent, whereas the benchmark 7.26 per cent, 2033 government bond settled at 7.06 per cent on Tuesday. Moreover, the cut-off on the 15-year state bonds was set at 7.36 per cent, which was 20 bps higher than the yield on the 14-year 7.41 per cent, 2036 government bond. “Private insurers are going for SDLs (state development loans), because the yield on long-term papers is higher there,” a dealer at a primary dealership said.

Typically, insurance companies stock up on bonds, and they do not trade bonds actively in the secondary market, dealers said. “SDLs are good instruments to hold on to, and insurers are always on the buying side; they rarely sell,” a dealer at a state-owned bank said. “Banks have a mandate; otherwise SDLs are good instruments to be kept in HTM accounts.” 

Additionally, lack of demand for long-term bonds was reflected in the primary market where the coupon on the new 30-year paper was set at 7.30 per cent last Friday, against the market expectation of 7.28 per cent.

Going forward, dealers expect the yield spread between the 10-year paper and the 14-year paper to widen as the yields on short-term bonds are expected to remain steady because the central bank is unlikely to start cutting the policy repo rate any time soon.