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ShareThe current limit for HTM is 25% of net demand and time liabilities (NDTL) and given the huge borrowing programme of the government (Rs 4.5 lakh crore gross borrowing, or 6.8% of GDP), banks have been forced to exhaust this limit.
The banking system is the single largest subscriber to government debt as government debt is internalised. Domestic savings are channelled in part to government debt through the banking system by maintaining a statutory liquidity ratio (SLR) of 24%. The government is the single largest borrower in the domestic market and the banking system deposits fund most of its requirements.
The scale of government borrowing has gone up almost three-fold over the last two years. The government has been forced to resort to fiscal stimulus to counter effects of a global recession on domestic growth.
Fiscal deficit has doubled from close to 5% of GDP to over 10% of GDP. The deficit is being financed through market borrowings. The size of the government borrowing has led to 10-year benchmark bond yields moving up from 5% levels seen in January 2009 to levels of 7.5% in September 2009.
The banking system, which subscribes to a large part of the government debt, has borne the brunt of the rise in yields. The system has almost exhausted the HTM limit and has no appetite in their mark-to-market (MTM) portfolios, given the MTM losses staring at them and the fact that the government bond supply is endless.
It is only fair to give respite to the banks by enabling them to transfer bonds into the HTM portfolio given that the government is highly reliant on banks to subscribe to their debt.
Banks, on their part, have been cautious on their holdings in government bonds and have restricted their exposure to less than 28% of their NDTL, despite good deposit growth at 20% plus levels and weak credit growth at 15% and below levels.
The RBI on its part is preparing for a withdrawal of the accommodative policy at the earliest, given incipient inflationary pressures.
Given that withdrawal of accommodative policy signals higher interest rates ahead, banks are better off not subscribing to government bonds for a mark-to-market portfolio.
However, without the banks' support for government debt, the borrowing cannot go through smoothly.
Hence, an increase in HTM cap and allowing more frequent transfers from MTM portfolios to HTM portfolios (till the government goes back on fiscal consolidation path or reliance on banking system support for government debt decreases) will place less pressure on banks' bond portfolios.
Inflation as measured by the wholesale price index (WPI) came in at negative 0.12% for the week ended August 29, 2009, against expectations of a negative 0.10% rate. The high base effect may wear off sooner than expected on sustained rise in primary article inflation.
Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) auction of the RBI remained high with bids for reverse repo crossing Rs 1.3 lakh crore. Overnight rates were at 3% levels. Liquidity will continue to be high in the system, keeping overnight rates low.
Government bonds
Government bonds saw yields move down week-on-week on hopes of a hike in the HTM limit. The 10-year benchmark bond, the 6.90% 2019 bond, saw yields move down by 8 basis points to close the week at 7.36% levels.
The five-year benchmark bond, the 6.07% 2014 note, saw yields move down by 2bps to close at 7.21% levels. The 7.94% 2021 bond saw yields almost unchanged at 7.93% levels, while the long bond -- the 8.24% 2027 security -- saw yields close flat 8.16% levels.
The government auctioned Rs 11,000 crore of bonds last week. The bonds auctioned were the 7.40% 2012 bond for Rs 5,000 crore, the 6.35% 2020 bond for Rs 4,000 crore and the 8.28% 2032 bond for Rs 2,000 crore. The cut-offs came in at 6.83%, 7.84% and 8.28%, respectively. The government is scheduled to auction Rs 11,000 crore of bonds this week.
The bonds to be auctioned are the 7.02% 2016 bond for Rs 5,000 crore, the 6.90% 2019 bond for Rs 4,000 crore and the 8.27% 2024 bond for Rs 2,000 crore.
The RBI purchased Rs 4,300 crore of bonds in the open market operations (OMO) purchase auction last week. The bonds purchased were the 6.07% 2014 bond for Rs 3,070 crore, the 7.49% 2017 bond for Rs 1,070 crore and the 7.40% 2035 bond for Rs 210 crore. The cut-offs were 7.14%, 7.45% and 8.20% respectively.
Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) yields were flat in the 91-day T-bill auction held last week with the cut-off on the 91-day T-bill auction held on September 9 coming in at 3.40% against a similar cut-off seen in the previous auction.
The 364-day T-bill auction saw the cut-off coming in at 4.60% against a cut-off of 4.34% in the previous auction. The RBI is auctioning Rs 5,000 crore of 91-day T-bills and Rs 3,000 crore of 182-day T-bills this week.
Corporate bond yields were higher week-on-week on worries of RBI tightening liquidity. Five-year benchmark bonds traded higher by 6bps at 8.56% levels, while 10-year benchmark bonds traded higher by 5bps at 8.90% levels.
Five-year spreads closed at 123bps levels while 10-year spreads closed at 140 bps levels, up 10bps and 13bps respectively. Corporate bond yields are likely to remain pressured on worries of liquidity tightening measures by the RBI.
Overnight index swaps (OIS) saw the curve move up week-on-week as the market factors in liquidity tightening measures by the RBI. The five-year OIS yield closed higher by 28bps at 6.70% levels while the one year OIS yield closed higher by 41bps at 4.90% levels. The one-over-five spread closed down 13bps at 180bps levels. The OIS curve is likely to flatten further as market looks factors in higher rates at the short end of the curve.
The author is head-fixed income, IDFC Mutual Fund. Views are personal.
