RBI repo nod likely for AAA corp bonds

The Reserve Bank of India (RBI) is likely to allow the use of triple A-rated corporate bonds for repo (repurchase) transactions to reduce liquidity risk.

Repo transactions are currently permitted only on Central government securities, treasury bills and state development loans. Partly addressing the liquidity risk will supplement the efforts of the Central government in resurrecting the moribund secondary market in corporate bonds.

"We expect the RBI to extend repo facility to corporate bonds. An important concern of the RBI may be the credit risk embedded in corporate bonds. Allowing repo transactions in triple A-rated corporate bonds would partially address the credit risk issue in such transactions," said IDBI Capital Markets in a report on its expectations from the RBI's quarterly policy review on January 31.

The government is also expected to announce a slew of measures aimed at developing a vibrant corporate bond market, which is imperative for raising funds for the country's huge infrastructure requirements.

The RBI is also expected to address certain structural issues affecting the financial sector.

These include decontrolling the savings bank rate, which currently is 3.5 per cent, and introduction of STRIPS (separate trading of registered interest and principal securities). STRIPS is the process of separating a standard coupon bearing bond into its individual coupon and principal components.

Introduction of STRIPS will make zero-coupon sovereign bonds available to investors and traders. The RBI had appointed a working group for operationalisation of STRIPS, which had presented its report recommending the modalities for its introduction.

"The RBI may announce a road map for the introduction of STRIPS. In order to provide support to this budding market, we expect the RBI to announce an official window through which investors can buy and sell STRIPS with the RBI. Such support from the RBI would lead to a more active STRIPS market and would eliminate fears of non-availability of an individual interest STRIPS, which would prevent reconstitution or being stuck with an illiquid STRIP," said IDBI Capital Markets.

The RBI is also likely to propose a forward move for allowing banks to participate in interest rate futures. Banks' participation is currently restricted only for hedging their interest rate risks residing on their balance sheets.

Interest rate options are conspicuous by their absence. Options are an important tool for hedging interest rate risk for financial sector entities as well as corporates. Options, unlike other derivative products, allow for quantification of risk upfront.