Rising bond yields force public banks to turn sellers

State-owned banks, which are normally buyers when the bond markets are depressed, have turned sellers this time round.

These banks have started offloading in the market, in line with their foreign and private sector counterparts, to check losses on account of rising bond yields.

"Some public sector banks (PSBs) are selling aggressively as they had invested in longer tenure, high-yielding government papers," said a PSB dealer.

On the eve of the 25 basis points rate hike in the funds rate by the US Federal Reserve, most PSBs brought down the average maturity of their portfolio to 4-6 years from 7-8 years.

According to dealers, longer-end papers are the worst hit with a rise in interest rates as the risk perception goes up with the time period to maturity.

The high yielding illiquid papers were lapped up by Life Insurance Corporation, Central Board of Trustees and traders.

Though the effective return on illiquid papers (around 6-7 per cent) is not enough to compensate for the 9.5 per cent return assured by provident funds, there are no better instruments available that offer the sovereign status of the government papers, said a bond dealer.

Dealers maintained that, earlier, PSU banks were major buyers in the bond market and that used to trigger all-round buying.

"The inflation rate has gone up in the domestic market while the global industrial recovery is evident from the healthy jobs data and the consumer index figures. Therefore there is a strong signal for hardening of interest rates," said a banking analyst. The steepness of the yield curve is more evident in the longer term of the maturity rather than the short term.

Treasury officials feel the trend in short-term papers is primarily driven by abundant liquidity in the system, which is dependent on outstandings in the liquidity adjustment facility of the RBI.

Moreover, since April 2002, when falling interest rate regime kicked off, 10-year yields have fallen by almost 230 basis points, whereas yields on 91 day T- bills have come down by 165 basis points.