Rising yields and devolvement in bond auctions have become a concern for primary dealerships, which derive major income from trading in government securities. A pause in the monetary-tightening cycle and alternate sources of income are the only hopes, as the scenario is expected to worsen.
Three of the four government bond auctions have devolved on primary dealers since the beginning of the second-half borrowing calendar in October. Primary dealers (PDs) had to buy about 10 per cent of the Rs 82,000 crore of government securities auctioned in the second half of the year so far.
“When consecutive auctions devolve on PDs, and there is very little follow-up buying for the devolved paper from investors, it leads to a situation when traders, as well as PDs, look to unwind their positions and this at times results in distress selling after auctions,” said Pradeep Madhav, managing director, STCI Primary Dealership. As a result of the devolvement, yields on the 10-year paper closed marginally lower than the cut-off yield of 8.83 per cent in the auction on the same day.
According to the Reserve Bank of India's (RBI) Trends and Progress report, PDs’ net profit declined in 2010-11, primarily owing to a disproportionate increase in interest expenses and decline in other income. “The hardening of government security yields had an impact on the profits of standalone PDs,” said the report.
PDs are expecting the tightening of the monetary policy to end, and this would cool the yields from current levels. “This financial year is even more challenging. Things may improve if inflation cools, and RBI decides to take a pause in December. That would give us the opportunity to write back our losses and post profits this financial year,” said DVSSV Prasad, managing director of Delhi-based PNB Gilts. He said the firm was considering other sources of income to tide
over the current phase in its primary business. “We are waiting for the government's approval to start with the portfolio management service, which would fetch us income in the form of fees and commission,” he said.
In September, the government had said it would borrow Rs 52,800 crore more than the borrowing planned for the second half of the current financial year. This pushed yields on the ten-year benchmark government bond to three-year highs of around nine per cent. “There has been a substantial rise in government borrowing over the last couple of years, but the investor base has not increased at a similar pace. I think tax treatment, similar to quasi-government securities, would help bring high net worth individuals to invest in government securities,” said Madhav.
The cap of $10 billion on foreign participation was increased to $15 billion this month. “I expect yields on the 10-year benchmark government bond to trade at around 8.75 per cent by the end of March 2012, if government borrowing does not overshoot much, and the increased foreign investment limits are consumed,” said Madhav.
RBI is scheduled to auction Rs 13,000 crore of dated government securities tomorrow. Traders said the possibility of another devolvement, despite on Thursday’s bond purchase by RBI, could not be ruled out because of continuous supply, along with treasury bills and cash management bills and the tight liquidity conditions.
