Yield rise may hit banks' gilt kitty

Concerns that banks' gilts portfolio may depreciate in the first quarter of 2007-08 have resurfaced with government bond yields surging this month.

"Banks will have to book losses on their investments in gilts in the first quarter as yields are not likely to reverse till June," said Vikas Goel, executive director""treasurer and money markets, Calyon Bank.

Many bank treasury officials held meetings Saturday and Monday to measure the impact of the sudden rise in gilt yields.

"Earlier in March, we were not expecting depreciation in the first quarter," said Sivram Swamy, treasurer, Indian Overseas Bank.

Since March, yield on the 10-year gilt shot up by 35 basis points. Most of the rise happened last week after the government announced a series of unscheduled borrowings.

The out-of-turn borrowing, coupled with tight liquidity until July, is likely to keep gilt yields firm.

Finance Minister P Chidambaram on Tuesday said government's unscheduled borrowing of Rs 110 billion was to fund State Bank of India's share purchase from the Reserve Bank of India.

"The government already has an overdraft under WMA (ways and means advances) from the RBI. Further, they (government) will have to pay around 40,000 crore (400 bln rupees) to RBI as SBI stake transfer amount by June end," said a senior treasury official at a private sector bank.

The SBI stake transfer will be a cash neutral transaction, with the central bank paying back the amount that it would get from the transfer to the government via a dividend cheque.

However, the dividend payout by RBI may not happen before August, a finance ministry official said on Tuesday.

Hence, government spending could be delayed as it is likely to get back the SBI share transfer amount only in August.

"Unlike other years, this time the government spending will not come very soon after the advance tax outflows, as the government will not have much funds before August," a senior treasury official said.

"If this happens (RBI's dividend payment in August), then yields will stay at 8.25-8.40 per cent in July," Goel said.

Over last two years, following the sustained upward pressure on interest rates, banks have been trimming down their trading portfolio, by shifting gilts to held-to-maturity category.

A smaller trading portfolio will be a saving grace for the banks as the impact of gilt yields fluctuation will be lower, bankers said.

"We had made some incremental provisioning in March and that will reduce the impact of depreciation on our trading book this time (April-June)," said IOB's Swamy.

Treasury managers can still hope to see better days in the second quarter (July-September) as liquidity is expected to improve with the series of capital flows coming via issues of UTI Bank, HDFC Bank, and ICICI Bank.