Informist, Wednesday, Mar 30, 2022
By Pratigya Vajpayee
NEW DELHI - It is easy to say bond yields will rise once the government starts its massive borrowing programme next week, but it's much tougher to predict the level at which bonds will find their feet amid volatility in the global market.
Sushanta Kumar Mohanty, general manager – treasury, Bank of Baroda, expects strong demand from investors to cap the 10-year benchmark yield at around 7.25%, around 45 basis points higher than the current level, even when fresh supply of bonds hits the market.
Yields May Touch The 7.25% Or 7.50% Mark, With Yields Being Contained Around 7.25% For Most Of The Year. RBI Is A Very Good Manager Now.
"What I'm trying to convey is that there is strong demand. Whatever rise in yields we will see will be transitory," Mohanty tells Informist in an interview.
"With the auction calendar, certain yields may go up, and there may be some disruption in the market, but I don't expect yields to rocket up," he said. "Yields may touch the 7.25% or 7.50% mark, with the levels being contained around 7.25% for most of the year."
Indian bonds yields have hardly risen despite the ongoing war between Russia and Ukraine sending commodity prices through the roof. Much of the stability though is due to the government hardly tapping the market for the last two months.
Mohanty says the enthusiastic bidding at recent auctions of state government bonds as well as corporate bonds indicates that the rising inflationary risks have not made investors lose their appetite.
To navigate the present volatility in the bond market, Mohanty says he prefers a strategy of buying short-term papers as of now and moving on to longer maturity bonds as the uncertainty over the course of bond yields eases.
He also sees the record high spread between the 10-year bond yield and the repo rate as a trading opportunity.
"At Bank of Baroda, what we are doing is that we are adding short-term papers currently," says Mohanty, who has spent over two decades in the Indian financial markets. "We will add long-term papers when more clarity emerges - after the borrowing calendar is announced and the monetary policy meeting takes place."
He is in favour of a one-year extension to the leeway that the Reserve Bank of India had granted to banks on held-to-maturity investment limit, until the implementation of the proposed norms on banks' investments removes the cap altogether.
The central bank had increased the limit for investment under the HTM category from 19.5% of net demand and time liabilities to 22.0% for statutory liquidity ratio-eligible securities acquired on or after Sep 1.
The enhanced limit will not be applicable from the new financial year starting Friday, which means that the large supply of government bonds would entail substantial mark-to-market risk.
The following are the edited excerpts of Mohanty's interview:
Q. Given the sharp rise in government borrowing and the possibility of higher interest rates next year, is there a need for a further dispensation on the HTM limits to cushion against mark-to-market losses?
A. If you see the valuation guidelines that RBI has brought in, there won't be any HTM limit after Apr 1, 2023. According to the accounting standards, banks can keep any amount of stock in HTM. If you see from that perspective, the limit will be brought down only for one year, and after April 2023, banks are free to increase HTM to the extent they want. Therefore, they may not bring it down right away. I feel that the current limit will continue for one more year, I don't see any harm in that. The entire market is expecting the same thing.
Q. The new guidelines dispense with the limit, but heavily restrict the sale of bonds from HTM. Are banks ready for this?
A. I don't see any issue. In addition to the dispensation on HTM limits, the RBI made one more announcement on sale of HTM and depreciation. Depreciation always comes below operating profit. Now, what the RBI has done is that the sale of investment, as well as depreciation is accounted under operating profit only. So, banks are not getting that benefit now. Whether you are getting income from interest income or from sale on investment, it doesn't make much of a difference as of today.
Whether banks are ready? Yes, they are. One or two small changes are being sought. For instance right now the sale allowed from HTM is 5%, maybe banks will ask for 10% or more, which is currently not allowed. But there are no bigger issues. Banks are adhering to the current guidelines.
Q. Will the restriction on HTM sale reduce the appetite to buy longer maturity papers?
A. In fact, putting in HTM resolves marked to market, but it hits the NIM. So, if you see with respect to the bottom line, putting in HTM doesn't give a bigger comfort. Banks will have to balance how much they will put in HTM and what duration to keep, because HTM provides only small comfort, it is not adding to the profit of banks.
Q. Given the upward pressure on bond yields amid global uncertainty and large government borrowing, at what levels do you foresee strong investor demand?
A. Two months ago, in Nov-Dec, it was difficult to predict where yields would go. Then the Russia-Ukraine war broke out, and we have seen yields at almost 7% on the 10-year bond. But despite oil being at such a high level, war still persisting, commodity prices having gone up, and inflation heating up, yields are still near 6.80%. One reason could be that there is no auction, but state auctions are taking place and the supply is being absorbed since there is good demand. If you see corporate bonds that were auctioned two days ago, they were below FIMMDA level. For instance, SIDBI and Power Grid, were sold at around 20-30 basis points below FIMMDA level. What I'm trying to convey is that there is strong demand. Whatever rise in yields we will see will be transitory. With the auction calendar, certain yields may go up, and there may be some disruption in the market. But I don't expect yields to rocket up. Yields may touch the 7.25% or 7.50% mark, with yields being contained around 7.25% for most of the year. RBI is a very good manager now.
Q. What strategy would you recommend to navigate the current volatility?
A. There is very good depth in this market, with a lot many players and varied views. At Bank of Baroda, what we are doing is that we are adding short-term papers currently. We will add long-term papers when more clarity emerges, after the borrowing calendar is announced and the monetary policy meeting takes place.
If you see the gap between the 10-year yield and repo rate, it is huge. A 280-290 bps gap is not small. It is an all-time high gap, which will decrease over time. The repo rate will go up in due course and yields may be around the same level and may rise by just 20-30 bps. For 20-30 bps, it is not easy to tell at what level you should add to the portfolio, because it should be a sizeable amount. If you take 1% of NDTL also, it will be around 8,000-10,000 crore (80-100 bln rupees). It will depend upon two things – the deposit growth and how credit offtake is taking place. If there is good credit offtake, which I'm not seeing yet, then investing in credit may be the route to take. But maybe 10-20 bps higher, people will be ready to add to the portfolio.
Q. What would be your recommendation for smooth conduct of the borrowing programme?
A. There is no magic wand. We require ample liquidity in the system to support growth, which is yet to reach pre-pandemic levels. OMOs (Open Market Operations), OTs (Operation Twist) and other similar operations impart stability to the system.
We have been repeating the same requests to the central bank, and the RBI has given many of the things. There is nothing more to ask from the RBI.
Q. What are your expectations from the RBI's upcoming monetary policy review?
A. RBI is very conscious about managing market expectations, and has been very successful in that. It has taken a consistent stand. And even now, their stance continues to be accommodative even though some of the central banks in other countries such as the US and UK have already started raising rates. The governor has clearly stated that they will keep abundant liquidity in the market.
The borrowing calendar will be released towards the end of this month, Apr 4 will be the first working day of the next financial year, and the Monetary Policy Committee's policy will be soon after that, on Apr 8. Certainly, the market will watch very closely what the RBI will do and say. To me, it looks like there will not be any stance change this time and there won’t be any rate hike as well. They will provide comfort to the market with the message, 'don’t worry, we are there'.
Q. Which segment has been the top performer in treasury this year and what challenges do you, as a treasurer, foresee in FY23?
A. Treasury works on volatility, and we manage the residual balance sheet of the bank. We did particularly well in the forex market, there was a good opportunity this year, premiums have moved either side. We believe that next year we will see similar moves.
I believe that next year as well, because of the many uncertainties unfolding, markets will be volatile and there will be ample opportunity to buy and sell in different markets. There won't be sale-on-investment income, but there will be interest income. And it will get added to the operating profit. Treasury will be a performer next year as well.
Q. What is your view on dollar/rupee given the higher oil prices? Also, what is the view behind the paying pressure in forwards over the last few days?
A. For the rupee, there is very good support at the 77 level. It is true that there has been buying pressure in the forwards market. There may be pressure for some more time. In 2018, dollar/rupee was trading around 74.50 level, and now also for almost the entire year it was trading around the 72-74 level. Hence, the rupee has not depreciated that much. I don't think there will be too much pressure on the rupee for the time. It will be capped around 77.00-77.50 for the rest of the year, but it is difficult to predict. Nobody had predicted the Russia-Ukraine war and that it will go on for such a long time and the disruptions that it will give rise to.
In India, we typically see these kinds of forward levels towards year-end, and if you see the last-day-first-day gap, a substantial amount of premium is going on there. End
Edited by Vandana Hingorani
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