The near term direction of bond yields will depend on the markets reception to bond auctions, and given that the current on the run bonds could go off the run soon, there could be some pain for yields in the auctions. Going past the auctions, the current weakness in global commodity markets with oil falling by 10% over the month of September and the threats to global growth in the form of debt worries globally will cap yields from going up too far and markets will start buying into higher levels of bond yields. It is a good time for investors to load up on long dated government bonds in the prospect of interest rates coming off down the line.
The government has increased the borrowing program for the second half of fiscal 2011-12 by Rs 52,872 crores. The second half borrowing will be Rs 220,000 crores as per the revised borrowing program. The provisional calendar for the borrowing released by the RBI, spreads the borrowing over the five month period from October to February 2011. The following tables show the monthly borrowing amounts assuming that the auctions are held on the last day of the indicative period and maturity buckets of bonds to be auctioned.
The borrowing is packed over the next five month with November 2011 and February 2012 seeing the most issuances. The 10 year to 14 year maturity bucket will see the most amount of issuance while the 20 years and above maturity bucket will see the least amount of issuance.
The market is worried on the 10 year to 14 year bucket as three of the current on the run stocks are close to their full outstanding limit. The RBI imposes a limit on the total outstanding amount of a single security, which currently stands at Rs 75,000 crores. This total outstanding limit is not a published limit but it is unofficially communicated to the market. The reason for the imposing of a limit on the total outstanding amount of a single security is that the government should not have stress in redeeming the bonds at maturity.
The current outstanding amounts on the on the run bonds are given in Table 3.
The space left in the 7.80% 2021 bond, the 8.13% 2022 bond and the 8.08% 2022 bond does not cover for the expected issuance of Rs 96,000 crores in the 2021-2025 (10-14 year) maturity bucket. The total space left in these on the run bonds is Rs 42,000 crores. The RBI has to fill up the difference of Rs 54,000 crores (Expected issuance of Rs 96000 crores less space left of Rs 42,000 crores) through issuance of other bonds in the 2021 to 2025 maturity bucket.
The question the market is asking itself now is what happens to the 7.80% 2021 bond, the 8.13% 2022 bond and the 8.08% 2022 bond if they reach their full outstanding limit of Rs 75,000 crores. There will be no further issuance of these bonds and the RBI will then bring in other bonds, which have less outstanding amounts for auctions. The new bonds will then become on the run. The old on the run bonds will then have no liquidity and traders will shun these bonds.
In such a scenario facing the markets, every auction of 7.80% 2012 bond, 8.13% 2022 bond and 8.08% 2022 bond will see higher cut offs in terms of yields as traders bid defensively due to the expected lack of liquidity in these bonds once they go off the run. Hence there is a good possibility that yields on the 7.80% 2021 bond, 8.13% 2022 bond and the 8.08% 2022 bond will rise by 20bps to 25bps above current levels of 8.43%, 8.48% and 8.48% respectively.
The RBI will have to handle auctions carefully by choosing the right bonds and making sure that current on the run bonds do not go off the run in this fiscal year.