For the first time in 17 months, the yield on the benchmark 10-year government paper crossed the 8 per cent mark on Monday, exposing banks to further losses on their bond portfolio.
According to data available on the central bank’s trading platform, the yield on the 6.35 paper maturing in 2020 hit a high of 8.02 per cent in morning trades before closing marginally lower at 8 per cent. The closing yield on Friday was 7.97 per cent. The yield on the benchmark 10-year paper is the highest seen since October 8, 2008, (see chart).
Market players, who are predicting that yields will rise further in coming weeks, said there was expectation of the Reserve Bank of India (RBI) raising interest rates in the wake of rising inflation. According to the latest available data, food prices rose 17.87 per cent in the week-ended February 20.
In addition, the Centre’s budgeted gross borrowing of Rs 457,143 crore during the next financial year was putting further pressure on yields, bond dealers said. By the end of the month, the government will finalise its borrowing calendar in consultation with RBI.
“Yields are moving up because the new borrowing programme is heavy and the direction of the monetary policy is towards a tighter policy, the only question is by how much. So, yields are moving up and the general direction will be in that direction only,” said HDFC Bank Treasurer Ashish Parthasarthy.
Michael Spencer, chief economist, Deutsche Bank (Asia) said the yield could touch a high of 8.5 per cent in the months ahead.
“There are not many trades happening in this (6.35 per cent 2020 paper). There is a dilemma. Nobody wants to sell or buy at this level. The yield on the 10-year benchmark could harden to 8.10-8.15 per cent by the end of the month,” IDBI Gilts Managing Director GA Tadas said.
A part of the reason for the rise in the yield of the 2020 paper was apprehension in the market that it may be replaced by a new benchmark when the government starts next year’s borrowings. From all available indications, the government will try to frontload its borrowing during the first half of the financial year to ensure that it does not impact private sector fund raising or borrowings by the government that are typically scheduled for the later part of the year.
Rising bond yields, which have an inverse relationship with their price, will put additional pressure on the bond portfolio of banks. On Saturday, State Bank of India Chairman OP Bhatt told Business Standard the bank might have to take Rs 500-700 crore hit on its portfolio. Similarly, Union Bank would have to bear a mark-to-market loss of Rs 50 crore if yields stay at 8 per cent, the management told analysts.
Banks are required to adjust the value of their bond portfolio, based on the price at the end of the quarter. Since December 31, 2009, the yield on the 10-year benchmark paper has gone up by 34 basis points. Even during the last quarter (October-December 2009), banks saw erosion in the value of bonds, as the yield on the 10-year benchmark paper increased by 51 basis points in anticipation of a rise in interest rates.
The problems of banks is compounded by the fact that most of them, especially the public sector players, because of the high government borrowings this year (Rs 4,51,000 crore), cannot park additional paper in the held-to-maturity (HTM) category that is free from provisioning requirements. The RBI guidelines allow banks to classify bonds in available for trade (in the initial 90 days of purchase), held-to-maturity (with a 25 per cent cap) and available-for-sale category. Some banks had approached the regulator with a proposal to increase the HTM ceiling, but RBI turned down the suggestion.
In the absence of credit demand, banks have invested more in government securities. As against the regulatory prescription of 25 per cent, as on January 15, commercial banks’ holdings of statutory liquidity ratio securities was 29.9 per cent of their net demand and time liabilities, compared to 28.1 per at the end of March 2009. Excess SLR investments were estimated at Rs 226,720 crore as on January 15, 2010, 33.49 per cent higher than Rs 169,846 crore at the end of March 2009.
