With just a day to go before the deadline for foreign institutional investors (FIIs) to invest their additional quota of close to $5 billion in government bonds expires, dealers said a fair share of the quota may be unutilised.

?The bidding was enthusiastic with most of the quota being bid for but some of the limit would probably lapse,? said Ananth Narayan, Regional Head, Fixed Income and Currencies, South Asia. The main reason for this, dealers say is the anticipated increase in interest rates by the central bank, at its next meeting on January 25. ?It?s understandable that investors would hesistate to buy bonds at a time when interest rates are headed up,? observed the treasurer of a leading bank.

Moreover given that rupee has been volatile, investors would be forced to hegde their exposures which would push up the costs. Limits to buy both corporate bond gilts, auctioned in early December 2010, to FIIs were almost entirely taken up. FIIs were given 45 days to utilise the new limits allocated in the auction to buy gilts and 90 days to buy infrastructure bonds, both with a residual maturity of five years.

The auctions followed a move by the government, in late September, to deepen the debt market and allow infrastructure companies and the government to access additional foreign capital to the extent of $5 billion each. FIIs can now collectively buy gilts worth $10 billion and corporate bonds worth $20 billion, taking the cap on foreign investors holdings of debt to $30 billion.

In late September 2010, the finance ministry had upped the limits for investments by FIIs in gilts and bonds of infrastructure companies, with residual maturies of five years. The Securities and Exchange Board of India (SEBI) on Friday announced that $5 billion worth each of gilts and corporate bonds, issued solely by infrastructure companies, would be auctioned on December 2, 2010.

Net FII inflows into the Indian debt market have been strong given that Indian paper fetches higher yields compared with those available in western markets, even after taking into account hedging costs. In 2010, the market saw strong inflows of more than $10 billion. As a result of more issuances by Indian companies over the past year or so, volumes in the croporate debt market too have risen. FIIs have typically held the paper till maturity since they were mainly of a shorter tenure.

9-yr bond yield dips to 8.14%

The yield on the benchmark nine-year government bond dipped on Thursday with bonds extending their gains for three consecutive days. While the market is expecting the Reserve Bank of India (RBI) to hike key policy rates, it believes that central bank may not opt for a big hike so that growth isn?t hurt.

The yield on the nine-year bond, maturing in 2020 and carrying a coupon 7.8%, declined to 8.14% on Thursday as against 8.18% recorded on Wednesday. However, rates on three- month Certificates of Deposits (CD) were up at 9.10% from 9.03% on Wednesday. Meanwhile, banks on Thursday borrowed Rs 76,705 crore from RBI?s repo windows, as compared with Rs 81,805 crore on Wednesday. Companies raised funds through three-month Commercial Paper (CP), priced at 9.49%, little changed from 9.50% on Thursday. The weighted average rate on one-day call remained unchanged at 6.29%.The volume in CDs market fell to Rs 6,284 crore from Rs 6,578 crore on Wednesday while volumes in CPs shot up to Rs 1,804 crore from Rs 880 crore.

Said Harihar Krishnamoorthy, head fixed income, currency & commodities, First Rand, ?The lower than expected growth in country?s November industrial production of 2.9%, together with the high food inflation number of 16.9%, has left the market feeling that RBI might hike rates too much. Currently, there is some amount of trading in the market.?

Said Roy Paul, DGM, treasury, Federal Bank, ?At the beginning of January, market was expecting RBI to raise policy rates by 50 basis points. Now, it is expecting only 25 basis points. The expectation that the yield on 2020 paper would touch 8.50% by March, 2011 may not happen and any rise in policy rate hikes by RBI beyond 25 basis points may push the yields to 8.50% in the middle term.?