After 11 years, mkt borrow ends without devolvement

Informist, Friday, Feb 16, 2024

By Nishat Anjum and Aaryan Khanna

MUMBAI – The record borrowing and liquidity deficit in the banking system notwithstanding, the government's gross borrowing programme for the current financial year ending March sailed through without a single devolvement, a feat last witnessed more than a decade ago.

Bond traders had cheered when the gross borrowing programme was announced last February, because the record ask of 15.43 trln rupees was about 400 bln rupees short of what it had feared. That sentiment seems to have largely lasted throughout the year with the government completing the market borrowing without a single devolvement, the first such instance since 2012-13, according to Reserve Bank of India data.

"It's not only the fact that there was no devolvement, its more or less unprecedented how the market reacted with a great degree of confidence," Vikas Goel, managing director and chief executive officer at PNB Gilts, said. "Despite 'withdrawal of accommodation', a rather aggressive stance of the Reserve Bank (of India), the yields were very well-behaved."

The bid-to-cover ratio, an indicator of the demand for government securities, suggests that the demand for bonds was higher this year despite the record market borrowing. This year, the bid-to-cover ratio at the auctions averaged 2.61 compared with 2.52 last year. The bid-to-cover ratio is the amount of bids received in a primary issuance versus the amount sold.

During the year, the 10-year paper was the most issued as is usually the case, with issuances in the 7.26%, 2033 and 7.18%, 2033 bonds – the two benchmarks – totalling 3.27 trln rupees. The Reserve Bank of India set the cutoff yields on the benchmark 10-year paper in the auctions between 6.98% and 7.36% in the current fiscal. In 2022-23, the government had to shell out 7.17%-7.52% for 10-year bonds.

This comes against the background of interest rate peaking in India and around the world. After raising the policy repo rate by 250 basis points between May 2022 and February 2023, the RBI kept the repo rate unchanged at 6.50% and maintained the 'withdrawal of accommodation' throughout the year. Even the US Federal Reserve last hiked rates in July, with Fed officials guiding for a cumulative 75-bps of rate cuts in 2024.

The one disappointment for traders has been the constant pushback of rate cut expectations. Immediately after the pause in rate hikes in India, the 10-year yield dipped below 7% with expectations of a quick pivot to easing rates as early as October 2023. That hope now stands delayed by a year, which has contributed to the weak demand during the year for short-term bonds.

The flat yield curve -- the 364-day T-bill had a higher cutoff yield than the 40-year benchmark 7.25%, 2063 gilt this week -- allowed all sets of investors to generate favourable interest incomes. Though surprises on the inflation front, heavy net borrowing, and tightening liquidity saw demand tapering in Jul-Dec, there still was enough appetite at the weekly auctions on the view that interest rates would eventually fall and buoy prices.

This is despite the central bank surprising the market by imposing an incremental cash reserve ratio and hinting at the possibility of open market sales. Yet, bond yields recovered as demand from investors remained robust.

"We saw demand at every auction and no uncertainty around it. In previous years, uncertainty used to be around long-term bonds," Naveen Singh, head of trading at ICICI Securities Primary Dealership Ltd, said. "The surprise factor was the unprecedented demand coming from the insurance sector, both private and state-owned, from the EPFO (Employees' Provident Fund Organisation) as well."

The insurance sector has emerged as the largest gilt buyer, outstripping buys from banks, so much so that the government's issuance pattern has been tilting towards securities maturing above 14 years to match their liabilities better. The government issued a 50-year bond and a 30-year sovereign green bond for the first time in 2023-24, to cater to the demand from the insurance companies.

The frontloading of gilt supply in Apr-Sep was also helped by purchases by insurers, who deployed inflows from a bumper Jan-Mar 2023 to get ahead of a tax change announced in the Union Budget. Income from life insurance policies, excluding unit-linked insurance plans, with a premium of over 500,000 rupees a year was taxed starting 2023-24.

The second half of the fiscal has been underlined by foreign portfolio investors, after JP Morgan said on Sep 21 it would include India's gilts on its Government Bond Index – Emerging Markets suite. While traders had already been betting on the inclusion, which was in the works for a decade, they redoubled their purchases after the announcement expected bond buys of around $30 bln. Bloomberg has also proposed to add India's bonds under the fully accessible route to its Emerging Market Local Currency index, which is likely to be confirmed this month, dealers said.

The RBI has designated most bonds that the government has issued this year under the fully accessible route, making them eligible for bond indices. According to Clearing Corp of India data, foreign portfolio investors have bought 855.84 bln rupees of these bonds so far this financial year, more than doubling their total holdings. Of this, over 650 bln rupees has been since October.

Though there are still doubts about the timing, the market is confident that the Monetary Policy Committee's next rate action will be a rate cut. This has driven active investors such as mutual funds to also stock up on long-term securities, in search of greater capital gains on their fixed income portfolios. With the government choosing to cut its gross borrowing in 2024-25 to 14.13 trln rupees, the purple patch is likely to extend for another year. End

US$1 = 83.02 rupees

Edited by Ashish Shirke

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