Govt seen keeping promise on floaters

The government is likely to keep its promise of issuing floating rate bonds in the second half of the year to March to help banks hedge interest rate risks, dealers said.

In the first half, government didn't borrow via floaters, but a borrowing strategy involving floaters is now seen compelling as inflation and yields appear headed up.

S Ananthanarayan, senior vice president of Kotak Mahindra Capital Co, expected floaters of around Rs 100-120 billion would be issued in October-December.

"The base effect of inflation is expected to taper away, and then inflation will take its toll, and yields could firm up," a dealer with a private bank said, setting out the case for floaters.

He expected issuance of floating rate bonds around December-January. Monday, the government released the calendar for gilt issuance in which it said it would raise Rs 580 billion in October-March.

The government has earmarked up to 20 per cent, or Rs 116 billion, of that issuance through floating rate bonds. The government had made a similar promise while releasing the issuance schedule for April-September.

However, floaters were not a part of the Rs 810 billion raised through the 19 bonds auctioned in the first half of the year.

"There will naturally be demand for the floaters as interest rates are seen rising," a dealer at a state-owned bank said. Floaters are generally used to hedge against rising rates due to their low duration and because their coupon is periodically adjusted to market changes.

The coupon on floaters usually varies with the average yield on a benchmark bond or T-bill. Hence, if rates rise, the return to investors rises too.

Many expect the Reserve Bank of India to soon hike its reverse repo rate to contain inflationary pressures that may emerge from the persisting high domestic liquidity and strong crude oil prices.

With the US Federal Reserve hiking the rates to 3.75 per cent, a continued rise in US rates also makes a case for higher rates in India. Future rate hikes, however, are in doubt in view of the toll that last months' Hurricane Katrina had on the economy.

Domestic inflation is seen rising because the benefit of a high base, which had kept the rate soft in recent months, is set to wear off. For the first time in eight weeks, wholesale price index inflation reversed its trend in the week ended September 3 by rising to 3.16 per cent from 3.01 per cent.

According to dealers, demand for floaters could rise because the Rs 580 billion of gilt issuance earmarked for October-March is unusually high.

In the October-March period of the previous year, government had issued only Rs 360 billion of gilts.

"The yield curve could be pressured up at the long-end because corporate as well as government borrowing will be high in the October-March period," a dealer at a foreign bank-sponsored mutual fund said.