Already rattled by the government?s move to borrow more this financial year, bond markets turned even more nervous as the yield on the ten-year benchmark paper breached the 8.80% mark in intra-day trades, for the first time in more than three years. The benchmark yield ended the session at 8.79%, a new three-year high, even as a third of the amount remained unsold in the R13,000-crore auction of government securities. Yields on the benchmark are now at levels last seen in late August 2008, just before investment bank Lehman Brothers collapsed to trigger a global financial meltdown.
The auction by the central bank, the second so far in the second half of the year, failed to attract enough buyers, compelling primary dealers (PDs) to pick up R4,038 crore worth of gilts, across maturities of seven and ten years. The first auction on October 7, for an amount of R15,000 crore, saw a 6% devolvement.
With inflation for September coming in at 9.7%, dealers were convinced that the Reserve Bank of India (RBI) would hike policy rates yet another time, when it meets to review monetary policy on October 25. Said ADM Chavali, head of treasury at Bank of Baroda: ?The market expects a 25-basis points hike from the RBI and yields could firm up further as bonds are dumped ahead of the announcement.?
The yield on the benchmark treasury paper has jumped nearly 50 basis points since the government announced on September 29 that it would need to borrow around R52,900 crore more in 2011-12. Should the government succeed in mopping up this amount, it would raise the total net borrowings for the current year to R3.96 lakh crore from R3.43 lakh crore targeted earlier. The government has said that it would borrow R15,000 crore less through treasury bills.
With most banks holding a surplus stock of government securities, appetite is limited. ?The market has no appetite to absorb the week-on-week supply from the RBI because it is already over-invested,? said J Moses Harding, head of global markets at IndusInd Bank. While banks are expected to hold 24% of net demand and time liabilities in the form of government paper, the collective holding is estimated at closer to 29%. While interest rates may be close to peaking, banks are nonetheless wary of picking up gilts.
Additional borrowings and the RBI?s ?hawkish stance are keeping banks away from the markets?, added Harding, who believes the yield on the10-year paper could inch towards the 9% mark, unless the supply of paper is reduced or the RBI decides to pause the hikes on October 25.
While credit offtake has come off somewhat since April when it was growing at above 20% y-o-y and is now increasing at 17% y-o-y, bankers believe there could be some shortage of liquidity.
According to Samiran Chakraborty, economist at Standard Chartered, total outflows from the banking system are likely to exceed total inflows by about Rs 35,000 crore in October. ?Consequently, the banking system’s liquidity deficit may widen to around Rs 90,000 crore by end-October. This is despite our conservative estimate of the seasonal increase in currency in circulation, estimated at around Rs 25,000-30,000 crore. Dealers say the supply shock could be eased if the central bank conducts open market operations to infuse liquidity.