The return on the bonds will be based on a formula provided by RBI that take the January wholesale price index of 170.3 as the reference. In January, the headline inflation was 7.28%. Treasurers say the wide range of bids could make it difficult for Reserve Bank of India (RBI) to arrive at a cut-off rate. The yield on the 10-year benchmark bond currently stands at 7.34%. Since this is the first auction, each bank will make its own calculation, said Manish Wadhawan, MD and head of rates at HSBC.
RBI will offer inflation indexed bonds worth R1,000-2,000 crore through a maiden auction on June 4, details of which will be announced soon. The auction follows the governments announcement to launch inflation protected securities to wean away demand from physical assets like gold and real estate and channel savings into financial savings. The auction procedure will be similar to that of a normal government bond auction under the governments market borrowing plan, but will have a higher share of 20% for retail investors under the non-competitive bidding segment. The bonds will initially have a tenure of 10 years and pay a fixed coupon semi-annually.
Calculations on what the real yield may be are varying across treasury desks. Public sector banks seem to be more conservative and say the real yield could be anywhere between 1.25-1.75%. IDBI Bank treasury head NS Venkatesh said the yield could even be below 1%. Wadhawan believes it could be between 1.5% and 2.5%.
It depends on what liquidity premium you assume, what discount you are willing to take, said a bond trader with another large public sector bank. Some traders are taking a hint from the recent ten-year inflation-indexed bonds issued by Larsen & Toubro, which issued these securities at a fixed coupon rate of 1.65%. Traders say the real yield on government issued inflation index bonds may be lower than that of a private issuer.
But traders in foreign and private banks and primary dealers cautioned if real yield is set below 1.50%, demand for the bonds may be muted. If it gets priced around 1.00-1.50%, the product may not take off. The trading in the market will eventually bring the yield down, said Nirav Dalal, who heads debt capital markets at YES Bank.
Sandeep Bagla, the senior vice president at ICICI Securities Primary Dealership, believes initially the market can ask for a higher premium and the real yield could reduce over time as inflation expectations are tapering.
We are not able to identify natural buyers for the bond when the visibility on inflation is benign, he said.
Also, bond traders expecting higher coupon said L&Ts issuance cannot be taken as a reference as the quantum of bonds issued is very small. A corporations bond cannot be a reference for the pricing of a sovereign bond, it has to be the other way, said Bagla.