India Bonds Slip as States Plan Bigger Borrowing; RBI Steps In

Indian government bonds weakened in early trading on Monday as investors turned cautious about a bigger borrowing plan announced by state governments. On Tuesday, states are scheduled to raise Rs.354.50 billion, equal to about 3.94 billion dollars, through bonds. This amount is Rs.200 billion more than what had originally been planned.

How It Affects

When states issue a larger number of bonds, prices of the bonds fall and yields increase. This is basically based on the supply-demand theory, as demand from investors may not rise at the same pace as the number of bonds increases, prices may fall. Prices of bonds and yields move in different directions. If the price of the bond increases, yields fall, and vice versa. This is the reason why bond prices fall when states announce heavy borrowing.

What Happened Last Week

Despite these concerns, the yield on India's 10-year government bond actually fell by 4 basis points last week, marking its sharpest weekly decline since early September. The fall in yields and hike in prices happened as traders purchased bonds in anticipation of the Reserve Bank of India's (RBI) intervention in the market by buying government bonds and injecting cash into the banking system.

Supply and Liquidity

Now, with the larger state debt sale scheduled for Tuesday, traders are worried that the sudden increase in supply will outweigh demand. On Friday, the government's debt auction ended with cutoff yields higher than expected. A cutoff yield is the minimum interest rate at which investors agree to buy bonds during an auction. Higher cutoffs yield show that investors are demanding more returns before lending money.

One trader at a private bank explained that there is little motivation to buy bonds at the moment because the banking system is short of cash and the supply of bonds is greater than the demand, as reported by the Economic Times. India's banking system has been facing a liquidity deficit since December 16. As of Friday, the shortfall stood at Rs.626.7 billion.

RBI Steps In with Purchasing Bonds

To ease this shortage of cash, the Reserve Bank of India announced that it will buy Rs.500 billion worth of government bonds on Monday. This is the central bank's third open market purchase of bonds this month. So far in December, the RBI has already bought Rs.1 trillion worth of bonds. In addition, it carried out a foreign exchange swap worth 5 billion dollars. The RBI has also scheduled another buy/sell swap worth 10 billion dollars on January 13.

Traders remain hopeful that these steps by the RBI will ease the cash crunch and create conditions for bond prices to rise steadily in the coming weeks.

Interest Rate Swaps Stay Flat

Meanwhile, trading in India's overnight index swaps showed little movement. Often called OIS, overnight index swaps are a type of financial contract where two parties exchange fixed and floating interest payments based on a benchmark rate. Investors use these swaps to hedge against changes in interest rates or to speculate on future moves. The one-year OIS rate stayed at 5.4725 per cent, the two-year OIS rate was unchanged at 5.555 per cent, and the five-year OIS rate stood at 5.93 per cent. The lack of movement suggests that investors are waiting for clearer signals before making new bets.

Disclaimer

The recommendations made above are by market analysts and are not advised by either the author, nor Greynium Information Technologies. The author, nor the brokerage firm nor Greynium would be liable for any losses caused as a result of decisions based on this write-up. Goodreturns.in advises users to consult with certified experts before making any investment decision.