As Modi govt revises borrowing plan, yields on 5-year bonds move upwards

 The yields on the five-year bonds jumped on Friday, but the benchmark 10-year remained relatively calmer after the government announced extra borrowing of Rs 1.1 trillion, to be raised equally in five and three year tenures, to compensate states on good and services tax (GST) shortfall.

Separately, the central bank announced Rs 10,000 crore secondary market purchase of state bonds, it’s first in history, to be conducted on Thursday next week. The open market operations of state development loans (SDL) were announced in the monetary policy to bring down yields of the state bonds so that they can borrow near about the cost the centre is paying for its borrowing. In the first such SDL OMO, the RBI will buy bonds of Andhra Pradesh, Arunachal Pradesh, Assam, Bihar, Chhattisgarh, Goa, Gujarat, Haryana, Himachal Pradesh, Jammu Kashmir, Jharkhand, Karnataka, Kerala, Madhya Pradesh and Maharashtra. Other states will likely find space in the OMO in later OMOs. The RBI has no fixed amount earmarked for how much OMO of state loans it will eventually do, but the central bank will likely chip in to cool the borrowing costs of state as and when required.

However, the need for extra borrowing by the states is significantly reduced now as the centre is now borrowing on their behalf. This can help raise the money at much cheaper rates than what the states would have paid themselves to borrow from the markets.

Bond dealers as such didn’t seem very perturbed with the extra borrowing, but said the initial reaction on the five and three year bonds would be adverse because they also declined by about 25-30 basis points after the policy on October 9.

The yields on the 10-year bond was trading at 5.913 per cent from its previous close of 5.898 per cent, the 5-year bond rose to 5.257 per cent from its previous close of 5.161 per cent at 12.55 pm. The yields on the three-year bond rose to 4.751 per cent, from its previous close of 4.718 per cent on Thursday.

“The incremental borrowing, while it will put pressure on the market, is in a way a positive. It will put an end to the Centre-State GST shortfall controversy, at least for the time being. It does away with the incremental state borrowing on this count,” said Joydeep Sen, fixed income consultant at Philip Capital.

Besides, the government is raising money for the shortfall in GST cess and not for its other expenditure, and hence the deficit is being maintained for now, bond dealers and economists said.

“While the overall supply/demand balance (across state + central government) of bonds is unchanged, we see this as a negative near-term development. However, while the government’s financing challenges (due to the wider fiscal deficit) remain, they may now be less inclined to rely on market borrowing to finance this gap,” said Nomura.

“Irrespective of the market's knee jerk reaction on Friday, one feels that the current set of announcements will eventually help in reducing uncertainties and anchoring market sentiment over the coming weeks, especially given the intelligent selection of the maturity buckets for the additional borrowing that enjoy strong demand. The current set of announcements may also lead to further flattening of the yield curve, thereby inducing better transmission of the RBI's monetary easing,” said Siddhartha Sanyal, Bandhan Bank's chief economist and head of research.

Following the government’s announcement, the Reserve Bank of India (RBI) came up with a revised issuance calendar where it said that the amount will be raised at Rs 55,000 each in three years and five years’ securities.

With this, the government will be borrowing Rs 4.88 trillion for the rest of the financial year. On September 30, the RBI had said the government planned to borrow Rs 4.34 trillion for the second half of the fiscal. Of this, Rs 28,000 crore has been raised earlier, and another auction of Rs 28,000 crore will be done today.

The auctions under the revised calendar will start from the next week.

The bond market has heaved a sigh of relief after the October 9 monetary policy. The central bank had assured of ample support to the market, and doubled the secondary market bond purchase programme to Rs 20,000 crore. The first such open market operations (OMO) conducted on Thursday showed the central bank accepted full Rs 20,000 crore as it had originally promised. This is a departure from the central bank’s earlier stance of rejecting bids on 10-year bond auctions and even cancelling an OMO.

10-year bonds rally from 3-month low as RBI brings in 'Operation Twist'

Benchmark 10-year bonds rallied from near a three-month low after the central bank said it will buy longer-tenor bonds while selling shorter debt in a move reminiscent of the US Federal Reserve’s Operation Twist.

The Reserve Bank of India will buy 100 billion rupees ($1.4 billion) of the 6.45 per cent 2029 debt and sell an equal amount of notes maturing next year in an auction on Monday, it said in a statement.

The yield on the 2029 debt dropped as much as 15 basis points to 6.60 per cent, the most in more than two months. The 7.57 per cent 2033 yield also slid 15 basis points. Shorter bonds fell with the 7.32 per cent 2024 yield rising 16 basis points to 6.67 per cent.

The move had been suggested by some traders and strategists as a way to pass on more of the central bank’s five rate reductions this year to businesses and individual borrowers. With investment and consumption both weak in India, policy makers are trying to spur credit and lift growth from a six-year low.

“This will address the steepening yield curve to some extent,” said Paresh Nayar, currency and money markets head at FirstRand Ltd. in Mumbai.

RBI-operation-twist

The concept is similar to Operation Twist used by the Fed in 2011-2012 in an effort to cheapen long-term borrowing and spur bank lending. The Fed then swapped short-term Treasury securities for longer-term government debt, which reduced the gap between two- and 10-year yields.

In India, the term premia -- difference between the benchmark 10-year yield and the RBI’s policy rate -- stands at 160 basis points, higher than the typical spread of less than 100 basis points.

The high yields in the longer end reflect concerns about the government adding to record borrowing as it gets ready to prime the economy. The slowdown has reinforced doubts about the administration meeting its budget aim of 3.3 per cent of GDP this fiscal year.

“The RBI should increase the intensity of its Operation Twist via more vigorous switches of government bonds focused on securities in the tenure of 7-10 year plus,” said Madhavi Arora, economist at Edelweiss Securities Ltd.

Not all agree the RBI’s move will work. Selling shorter bonds may blow up yields given the concentration of trading positions in that segment, ICICI Securities Primary Dealership Ltd. said in a note.

Also, while the RBI may pull down long-term yields, abundant cash in the banking system totaling 2.4 trillion rupees will cap shorter yields.

The multitrillion-dollar black hole engulfing the world's bond markets

There’s a multitrillion-dollar black hole growing at the heart of the world’s financial markets. Negative-yielding debt — bonds worth less, not more, if held to maturity — is spreading to more corners of the bond universe, destroying potential returns for investors and turning the system as we know it on its head. Now that it looks like sub-zero bonds are here to stay, there’s even more hand-wringing about the effects for mom-and-pop savers, pensioners, investors, buyout firms and governments.

Why invest in a bond that will lose you money?

Typically, bonds are the safest assets on the market, so many investors seek them out at times of heightened market stress, say a US-China trade war or tensions in the Persian Gulf. A bond can have a modestly positive coupon when issued by a government, institution or company, but once it starts trading, high demand by investors can push its price up — and therefore its yield down — to such an extent that buyers no longer receive any payment. Some funds track government bond indexes, meaning they must buy the bonds regardless of the yield. And some investors can still make positive returns on these bonds when adjusted for currency swings.

How much is being bought?

Negative-yielding debt topped $13 trillion in June, having doubled since December, and now makes up around 25 per cent of global debt. In Germany, 85 per cent of the government bond market is under water. That means investors effectively pay the German government 0.2 per cent for the privilege of buying its benchmark bonds; the government keeps 2 euros for every 1,000 euros borrowed over a period of 10 years. The US is one of the few outliers, with none of its $16 trillion debt pile yielding less than zero, but across the world, strategists are warning that the problem may get worse.

Why is this reason for worry?

Negative rates are at odds with basic principles of the global finance system. “One important law of financial logic — if you lend money for longer, you should see a higher return — has been broken,” wrote Marcus Ashworth, a Bloomberg Opinion columnist covering European markets. “The time value of money has essentially disappeared.” (Has it ever: The so-called century bonds issued by Austria two years ago, which mature in 2117 and initially offered a 2.1-per cent return, now yield about 1.2 per cent.) All this can push investors into riskier bets in the hunt for returns, raising the chances of bubbles in financial markets and real estate.

Who benefits from negative rates?

Governments, for one. The incentive to borrow money is never greater than when you are being paid to do so. Germany, for example, is being subsidized to issue debt over the next 20 years, though that does not necessarily mean it will boost spending.

Companies that issue bonds also reap the benefits of record-low borrowing costs. So do private-equity firms, which typically use leverage to acquire companies and see greater opportunities when (and where) capital is cheap. Homeowners with variable-rate mortgages also have reason to celebrate.

Who gets hurt?

Pension funds and insurers, traditionally big investors in government bonds, are in a particular predicament: Their liabilities grow steadily as clients age, but often they are required not to take on big risks. Banks see their margins squeezed.

They’re earning next to nothing from lending but still need to offer depositors a rate above zero to keep their business. In Germany, the ECB has come under political pressure for hurting the returns of savers. Central banks could run into the problem of hitting the so-called “reversal rate” — the point at which low borrowing costs start to harm rather than help the economy, should banks start to restrict loans. That could deepen any slowdown.

How did we get here?

Several of Europe’s central banks, otherwise unable to spur growth in the aftermath of the 2008-2009 financial crisis, cut interest rates below zero in 2014. Japan soon followed. The idea was to spur lending by charging financial institutions, rather than rewarding them, for parking money that otherwise could be put to use in the real economy. Since 2016, the ECB’s benchmark rate has been —0.4 per cent, meaning banks lose ^4 to store ^1,000 there. The sub-zero rates were supposed to be temporary but have endured. Traders are betting that the ECB will push its deposit rate ever more negative this year, driving record levels of bond yields below zero.

Why have negative rates lasted so long?

More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isn’t expected to get to its close-to-2 per cent inflation target over the next decade, according to a market-derived measure.

And the yield difference between US three-month bills and 10-year Treasuries is inverted, an indication that an economic contraction may be coming. Aside from the US Federal Reserve, few central banks that slashed interest rates during the credit crunch have managed to raise rates, meaning that during the next downturn they are likely to head further into negative territory.

Where’s all this heading?

In Europe, there are fears that the continent is following the path of Japan’s so-called lost decade, where policy makers struggled to revive anemic growth and inflation. Central banks have been keen to iterate that they still have tools in their locker to combat any slowdown, including rate cuts and more quantitative easing.

For markets, waning volatility is bad for trading. Geopolitical tensions over trade, and Britain’s exit of the European Union will keep driving investors into the safest assets, meaning demand will remain high for negative-yielding debt. But the push to find juicier returns with riskier bets raises the prospect of further fund failures or a new crisis