FOCUS: Oct-Mar borrowing a light snack for happy gilt market
By Aaryan Khanna and Nishat Anjum
MUMBAI/NEW DELHI – With all the gilt auctions in Apr-Sep completed without a hitch, the government's borrowing calendar for the second half of this financial year has also hit the right notes with bond traders, addressing both the needs of gilt investors and the relatively weak demand in some tenures.
The government will borrow 6.55 trln rupees through the sale of dated securities in Oct-Mar, the finance ministry said in a release late on Tuesday. With 8.88 trln rupees of borrowing already completed, the borrowing in Oct-Mar would complete the record gross borrowing target of 15.43 trln rupees for 2023-24 (Apr-Mar).
The Government Will Borrow 6.55 Trln Rupees through The Sale Of Dated Securities In Oct-Mar
Demand-supply dynamics have turned favourable for the bond market after the government concentrated its borrowing in the first half of the fiscal year ending March. The net market borrowing of 4.52 trln rupees in the second half will be a light snack for a market that has just bought gilts worth 7.29 trln rupees on a net basis in the first half.
Much to the market's relief, the heavy lifting in the second half of the financial year will be done by long-term bonds. This means the rate-sensitive short-term bonds will have less supply pressure, in line with requests from traders. Short-term bonds may not be favoured by investors as liquidity in the banking system remains in huge deficit and uncertainty looms over interest rates, dealers said.
Market participants now say that the borrowing programme will not need any significant buying support from the Reserve Bank of India, compared to the widespread view at the beginning of 2023-24 that such support would be required. Propelled by a favourable calendar, the yield on the 10-year benchmark bond is likely to decline to 7% or lower by March, dealers said. Today, the 10-year benchmark yield settled at 7.22%.
The borrowing pattern is skewed in favour of long-term bonds quite firmly, as it was in Apr-Sep, and the government cited demand from investors while introducing the first-ever 50-year gilt in the second half. The novelty of the bond may have elicited some surprise, but ultimately, its 300-bln-rupee issuance is likely to be mopped up entirely by life insurers, which may have demanded the gilt, dealers said.
"One of the great things about the Reserve Bank and the government of late is that they constantly engage with market participants," said Churchil Bhatt, executive vice-president at Kotak Mahindra Life Insurance Co Ltd. "Every insurer, to some or other extent, has an asset-liability demand for 50-year bond...there are (such) products in everyone's books."
The skewed demand may result in less-than-optimum price discovery at the auction but ultimately, the paper is unlikely to be traded and is destined straight for investment books without any discomfort for the rest of the market, dealers said.
In fact, the distribution of supply has been decided with a lot of nuance in the current calendar, dealers said. In 2022-23, the government issued the same quantum of both the 30- and 40-year gilts, which were well received. But starting this year, the 40-year bond has had a greater share of the borrowing calendar, as it was favoured by investors rather than the 30-year bond, which is a less appropriate fit for the asset-liability management of insurers.
The divide between the two maturities will only increase in the second half. Not counting green bonds, the government plans to raise 1.2 trln rupees through the 40-year paper and only 700 bln rupees through 30-year bonds. Even the green bond issuance in the 30-year segment is only a token amount of 100 bln rupees, spread across two auctions.
As is generally the case, the government will conduct the bulk of its borrowing through issuance of the 10-year bond. A total of 22.14% of the Oct-Mar bond issuances will be through sales of the 10-year paper, a tad higher than its 20.50% share in Apr-Sep. This has made traders averse to heavy buys of the 10-year bond, particularly with the share of the 14-year paper – another trading favourite – falling in the Oct-Mar calendar compared to Apr-Sep.
To be sure, the 10-year benchmark will always be in favour with bond traders, especially as its trade volume dominates the secondary market. But come December, when its auction size goes from 130 bln rupees to 160 bln rupees every fortnight, the yield spread between the 10-year and 14-year bond is likely to shrink, dealers said.
The government's redemption pattern is a strong offset to those pressures, another way that the Oct-Mar calendar is well thought out, dealers said. While there are no gilt redemptions in Jul-Oct, the government will repay 2.22 trln rupees to bond investors between Nov 2 and Dec 15.
"If you look at the weekly issuances, it looks like they have kept in mind the redemption pattern for deciding how much to borrow when," a treasury official at a state-owned bank said. "It's an extremely deft move on the drafting side, where they have given up uniformity to better fit the market."
Not many surprises are lined up in the Oct-Mar borrowing, which may keep buyers coming back for more, dealers said. Bank demand is unlikely to let up, with changed investment norms allowing increased bond purchases from April. Traders from mutual funds are in favour of stocking up on long-duration paper for its better capital appreciation when yields fall, while insurers and pension funds are often cash-rich in Oct-Mar and will be looking for opportunities to invest.
Foreign investors are also likely to stock up on bonds maturing between five and 10 years towards the end of the fiscal year after JPMorgan announced India's gilts will be included in its emerging market debt index from June. Passive flows are expected to amount to $24 bln-$30 bln when the process completes in March 2025, while front-running from active foreign and domestic investors may start "immediately" this financial year itself once US Treasury yields and crude oil prices ease from the current highs, dealers said.
"The government has correctly identified where demand is coming from, both on the insurer side and the bank side," said Marzban Irani, chief investment officer – debt, LIC Mutual Fund. "Interest rates have peaked, so people would not mind stocking up on duration. I would recommend going as long as possible, though the 10-year looks attractive as spreads are not very attractive for longer durations."
While the central bank kept the borrowing pattern little changed at the short end, the share of bonds maturing in seven years or less has been trimmed to 25.95% from 28.27% in Apr-Sep, as banks had sought. The small cut would not necessitate an overhaul of portfolios, even on the asset-liability management front, dealers said.
Banks had suggested lower issuance at the short end owing to the prevailing tight liquidity. From Sep 18, banking system liquidity has remained in deficit. This was the first time since Aug 24 that liquidity was in deficit, with payments for advance tax having drawn out over 1 trln rupees from the banking system. Adding to the deficit were outflows for payment of goods and services tax last week.
"Banks will buy. It is just that if liquidity is tight, their (banks') short-term buying cost will go up by 10-15 bps," said Naveen Singh, head of trading, ICICI Securities Primary Dealership Ltd. "But the liquidity thing is a bit more dynamic, since say inflation cools off a bit in a couple of months or by year-end. So, liquidity might ease off."
The market expects the yield spread between the benchmark seven- and 10-year papers to widen slightly going forward as the borrowing share of the seven-year paper has been reduced to 9.16% in Oct-Mar from 10.25% in the first half. This may result in a clear distinction between yields on bonds of less than seven years, followed by the 10- and 14-year bonds occupying a common part of the yield curve, and finally the 30-50-year bonds moving in line with the dynamics of long-term investor demand, dealers said.
Even as another rate hike is expected from the US Federal Reserve this year, India's policy repo rate is seen as having topped out. The RBI's Monetary Policy Committee has raised the repo rate by 250 bps to 6.50?tween May 2022 and February. The panel is expected to extend its rate pause, before finally cutting rates sometime in 2024-25.
"Surprisingly, the borrowing programme has gone very well, despite noise from the global market all over the place," Singh said. "G-Sec have behaved very well, the yields have largely been in the range of 20-25 bps, where other countries' bonds traded in a much wider range."
In August, CPI inflation moderated to 6.83% from a 15-month high of 7.44% in July. According to preliminary estimates, the market by and large expects retail inflation for September to be below the crucial mark of 6%, gilt market dealers said. The RBI has a medium-term inflation target of 4%, and a tolerance band of 2% on either side of the target.
The Oct-Mar borrowing calendar matches the uncertainties the market faces on the monetary policy front during the period, dealers said. It also gives the yield curve an impetus to steepen towards the end of the year, with gilt supply ending on Feb 16, foreign investment expected to redouble ahead of index inclusion, and more clarity on rate cuts in India and the US.
Anchored as it is by firm demand from long-term investors, the steepening bias of the yield curve will have to come from short-term yields falling quicker than other parts of the yield curve, rather than an increase in long-term yields, dealers said.
Not many in the market had anticipated that the government's record borrowing, its second in two years, would go without a hiccup when it was announced in the Budget. Helped by evolving market dynamics and adroit scheduling, the calendar could be considered a success for the government at its release itself – the next six months will tell whether investors have the chops to back up their words. End