Cogencis, Wednesday, May 15

By Shreya Tyagi

MUMBAI - It is fairly common for a new 10-year government bond to be labelled the 'benchmark' soon after its issuance, but to actually earn the tag requires capturing the largest share in daily trade volumes.

In this aspect, the current 10-year benchmark 7.26%, 2029 bond has set a record of trailing its predecessor in trade volumes for the longest period running, dealers said.

Even a good four months after its maiden auction in January, the 7.26%, 2029 bond has managed to rise only to the second spot in terms of trade volumes, even as it is used as a yardstick for pricing a wide array of fixed-income products. Meanwhile, the top spot continues to be occupied by the previous benchmark 7.17%, 2028 bond.

To put things in perspective, the 7.17%, 2028 bond took less than two months to surpass the preceding benchmark--the 6.79%, 2027 bond--in trade volumes, while the 6.79%, 2027 bond took a mere 15 trading days to take the baton from its preceding benchmark, the 6.97%, 2026 bond.

Typically, the liquidity of a bond gradually wanes when it is no longer offered at weekly auctions, which serves as an important mechanism for price discovery. However, Indian bond traders continue to prefer the 2028 bond to its successor, even as there has been no fresh supply of the previous benchmark paper since Dec 27!

The main reason why most dealers are holding on to the 7.17%, 2028 bond is that they see a strong possibility that the Reserve Bank of India would offer to buy it under open market operations in the coming months.

The central bank is widely expected to buy bonds worth at least 1.5 trln rupees in the current financial year that began on Apr 1.

To maximise the success rate of its bond purchase auctions, the RBI usually offers to buy papers that are widely held and have a large outstanding stock. Thanks to its erstwhile benchmark status, the 7.17%, 2028 bond resides in most portfolios, while the amount outstanding on the paper is a sizeable 1.13 trln rupees. The bond, therefore, fits the bill for the central bank's future purchases. 

Since last year, the RBI has mostly been buying illiquid bonds of relatively shorter maturities, but dealers believe that the market will eventually run out of short-term securities that can be offered profitably. The central bank would then have to look at other papers for its purchases, and the 7.17%, 2028 bond seems to be a likely contender.

For traders, the RBI's probable purchase of the 7.17%, 2028 bond is an event worth waiting for, as the central bank has so far shown willingness to buy papers at prices higher than those in the secondary market.

Moreover, some market participants hold the 7.17%, 2028 bond as a defensive bet, especially given the risks posed by the government's massive borrowing programme, and the result of the ongoing General Elections.

If market conditions were to take a turn for the worse, the incumbent benchmark 7.26%, 2029 bond would be more vulnerable because it is up for auction every alternate week, which means the market would eventually be flooded with its supply.

"Sometimes what happens is that when you say this paper (the 2028 bond) is trading more, it is because traders who want to take short-term views participate more in that bond because it's more liquid," ICICI Securities Primary Dealership Managing Director and Chief Executive Officer Shailendra Jhingan said.

Moreover, the current price of the 7.26%, 2029 bond would be lower than the average price of its holdings in most portfolios. At the time of its debut, the coupon on the bond was set 22 basis points below the prevailing yield on the 7.17%, 2028 bond, marking the widest spread between two consecutive 10-year papers in nearly five years. Because of the rich pricing of its holdings, trading the bond is not lucrative at times.

In contrast, the 7.17%, 2028 bond has been in circulation since Jan 5, 2018, and has seen yields surge to as high as 8.23%. The relatively cheaper holdings make it more viable for traders to churn this paper.

The market's penchant for the 7.17%, 2028 bond has manifested itself not only in trade volumes, but also in yield spreads. The yield on the 7.26%, 2029 bond is now at 7.37%, just 10 bps lower than that on the 2028 paper. Usually, the spread between two consecutive benchmark papers consolidates at around 15 bps.

However, the second-class status of the 7.26%, 2029 bond is unlikely to last much longer. As the amount outstanding on the benchmark security builds up to around 500 bln rupees over the next few weeks, its trade volumes will surpass those of the 7.17%, 2028 bond, dealers said.  End

Edited by Akshit Harsh