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ShareMumbai: It's ironical. The bond market had to incrementally absorb only Rs 4,500 crore of government bonds in March 2009 against the additional government bond supply of Rs 46,000 crore.
The 10-year yield in the same period moved up 100 basis points from 6% levels to 7% levels. The Reserve Bank of India bought Rs 41,500 crore of bonds in March, in order to cause minimum pain to the markets in absorbing the additional supply. RBI had also cut reverse repo and repo rates by 50bps in the same month while inflation trended down to close to 0%. Given the picture painted above, one would wonder why bond yields moved up so sharply in March.
One answer is that the market was worried about government borrowing for fiscal 2009-10. However, looking at the Rs 2,41,000 crore of gross borrowing for the first half of fiscal 2009-10 against the government-bond and MSS-bond redemptions of Rs 66,000 crore and RBI's stated bond purchases of Rs 80,000 crore, the market will have to incrementally absorb only Rs 95,000 crore of gilts in a six month period, which is not very heavy.
Market sentiments should have improved on the back of the borrowing calendar announcement, but the 10-year benchmark yield continues to remain at 7% levels. Why the bearishness?
The bearishness stems from the fact that the investor base for government bonds has not expanded. To be sure, the government is slated to borrow Rs 3,60,000 crore in fiscal 2009-10, double the size of borrowing was done in the each of the last eight years (2000-2008). Given the increased size of the borrowing, debt managers must also ensure that the size of the market is bigger.
This would mean increasing the number of primary dealers who underwrite government bond issuances, bringing in retail participation through mutual funds by giving tax sops, giving the banking system more leeway in the held-to-maturity category of investments and selectively marketing long-dated government bonds to long-term investors, both in the domestic and international markets.
Introduction of interest rate futures will also give the market a vibrant hedging mechanism and encourage active trading in government bonds. However, all these measures are long-term in nature and even with sustained efforts, it will take at least six months at the minimum to implement them.
So what is the best way to create demand for government bonds in the short term? One solution is private placement of bonds with RBI, which will reduce the supply in the market. This measure is a double-edged sword and when misused, can have long term repercussions, so RBI is extremely hesitant to take this step (rightfully so). The next best solution, then, is to front-end government bond purchases by RBI.
The central bank has announced that it will purchase Rs 80,000 crore of government bonds in the first half of fiscal 2009-10. They have spread these purchases over six months. Given that RBI has anyway committed to buying Rs 80,000 crore of government bonds, they might as well do it in the first three months of the fiscal. This will bring down bond yields sharply in the near term, giving RBI and the government enough time to widen the investor base for government bonds.
I am sure there are many more such suggestions resting with the public debt managers and the suggestions given above may have already been discussed. However, given the way bond yields moved in March despite RBI intervention, a failure by the market to absorb the supply may force the central bank to resort to quick-fix methods, and this is not desirable for the economy.
The author is head - fixed income, IDFC Mutual Fund. Views are personal.
