Gilts drop on higher auction size

MARKET ROUND-UP

Government bonds fell for the second day after the central bank said it will triple the size of debt sales meant to absorb surplus funds this week.

The Reserve Bank of India said on March 23 it will auction Rs 6,000 crore ($1.4 billion) of two-year notes on March 28, compared with Rs 2,000 crore of bonds in each of the last two weeks. The additional supply may leave banks, the biggest buyers of government debt, with less funds to purchase fixed-income securities.

"The bond market wasn't expecting the increase," said Poonam Tandon, a trader at Development Credit Bank Ltd in Mumbai. "We aren't seeing any positives for bonds in the immediate term and yields are likely to harden."

The yield on the benchmark 8.07 percent bond due in January 2017 rose 5 basis points, or 0.05 percentage point, to 7.99 per cent at the close, according to the central bank's trading system. The price fell 0.34, or 34 paise per Rs 100 face amount, to 100.48. Yields move inversely to prices.

The central bank resumed the sale of the so-called market stabilisation bonds earlier this month after a gap of almost two years to ensure excess money in the banking system doesn't stoke inflation. Consumer prices rose 6.46 per cent in the week ended March 10 from a year earlier, near a two-year high, a government report showed last week.

The cost of overnight funds rose to 13.5 percent from 9.5 per cent on March 23, making it more expensive to buy debt with borrowed money. The rate last week rose to the highest in at least eight years after cash in the banking system dwindled following a payment of advance taxes by companies on March 15.

Bonds also fell on concern an increase in crude oil prices to a three-month high will spur inflation. India, Asia's fourth-biggest economy, depends on imports to meet three-quarters of its annual energy needs.

"Inflation remains a concern, especially with higher oil prices, while prices on the manufacturing front don't seem to let up," Tandon said.

Reserve Bank Governor Yaga Venugopal Reddy, who will announce his next interest-rate decision on April 24, has raised the overnight lending rate eight times since October 2004 to curb inflation.

Starting in December, policy makers also raised the amount of cash that lenders must set aside to cover deposits, draining as much as Rs 27,500 crore from the banking system over four months.

The 10-year yield may rise as high as 8.25 per cent by the end of April as the government prepares to release its auction calendar for the fiscal year starting April 1, Tandon said.

The federal government plans to borrow Rs 1.55 trillion next fiscal year and may this week announce its borrowing schedule for the first half of the year.

The yield on the two-year note is 3 basis points more than the yield on the benchmark 10-year bond. The 10-year bond yielded 32 basis points more than the two-year note at the beginning of the year, Bloomberg data show.