PSUs forced to issue short-term bonds

Interest rates may be peaking, but mutual funds and banks' reluctance to look beyond five years has been forcing state-owned companies to, uncharacteristically, issue short-end bonds.

"This is purely due to the market conditions. As investor interest is stronger in short end rather than long end bonds, we have seen more issues in this tenure," said a dealer with a private bank.

State-owned firms, especially those funding public works and refinancing bank loans, traditionally issue bonds with a tenure of five years and above as these match the tenure of their assets.

Traders take positions only up to five-year maturities because "the demand is concentrated in the shorter end papers", said a merchant banker.

"The investors are mainly interested in up to five-year bonds. Beyond five years, there is an uncertainty about the interest rates," said a senior official at National Bank for Agriculture and Rural Development (Nabard).

Nabard, a regular borrower in the debt market, has also restricted its fund raising plans to shorter tenures. The bank has raised close to Rs 45 billion in the 1-5 year tenures in Apr-Jun, much above its borrowings of around Rs 35 billion through such bonds in the whole of 2006-07 (Apr-Mar).

Banks and mutual funds are unwilling to take a long-term view due to uncertainty surrounding the interest rates and fears of likely monetary steps by the Reserve Bank of India.

Though the declining inflation could reduce the odds for interest rate hikes, the abundant liquidity following huge capital inflows is still a concern.

The fund houses are also avoiding long-term bonds because bulk of their inflows are into liquid and short-term debt funds.

"A short-tenure paper throws open the issue to a larger investor base as mutual funds and banks would be interested. Longer tenures are dominated by insurance companies and provident funds," said the private bank dealer.

A section of provident funds and insurance companies""usually keen on longer term bonds""has also invested in short-term bonds as the yields could fall further going forward, merchant bankers said. The ample liquidity and a sharp fall in short-term yields are also prompting issuers to go for such bonds.

The yields on one-year bonds have fallen by almost 200 basis points to 9% from 11% in April. The 3-5 year bonds have also seen a fall in yields by 30-40 basis points.

"The investor base is also different as mutual funds and banks would be more interested here," said a dealer with a state-run life insurance company. Insurance companies and provident funds prefer 10-year and above tenures. "Insurance companies and PFs may not be interested in a yield below 10% for 10-year bonds," the dealer added.

The yield on 10-year bonds has been steady in the 10.00-10.15 per cent band since April.

Around Rs 40 billion has been raised through primary bond issuances by public sector companies in the first quarter of 2007-08 (Apr-Mar), half of which were in the 3-5 year segment.

Companies such as Power Finance Corporation (PFC), Indian Railway Finance Corporation and Rural Electrification Corporation, which issued 10-year and 15-year bonds in the first quarter of 2006-07 (Apr-Mar), have stuck to shorter tenures this year.

For instance, PFC raised around Rs 10 billion in FY07 through 3-year and 5-year bonds, and has already raised Rs 7 billion this year. Indian Railway Finance Corporation has raised Rs 12 billion through five-year bonds so far this year.