Alarmist headlines from Economic Times baseless
Rs 6000 crores of bonds unsold – 8th October 2011
Government bond auction fails – 15th October 2011
Headlines like the ones above in Economic Times is factually incorrect
Government bond auctions have suddenly come into the limelight with headlines of “unsold bonds”, “auction failure” and “devolvement”. The first two headlines have no basis and the third “devolvement” is both positive and negative. Higher than budgeted borrowing of Rs 53,000 crores has pushed up government bond yields in the last fifteen days. The market is worried about the quantum of supply with weekly auctions of Rs 13,000 to Rs 15,000 crores over the next few months and the absorption of this supply given RBI’s anti inflationary stance. The last two government bond auctions have seen the markets bidding at higher levels in terms of yields and have also seen the RBI devolving part of the auctions on to the underwriters. Hence the totally baseless headlines from major newspapers.
Government bond auctions are fully underwritten. The primary dealers (PD’s) underwrite the government bond auctions. PD’s have a minimum underwriting commitment (MUC), which are half the auction size and an additional competitive underwriting (ACU) which is equal to the MUC. The MUC plus ACU covers the total auctions size. The PD’s bid for underwriting commissions for the ACU through a multiple price based auction method. The RBI sets the underwriting commission based on the bids for underwriting received for the auctions.
The government on its part knows that every auction is fully underwritten and does not have to worry about auctions failing. The PD’s on their part look to generate bids for the auctions from banks, insurance companies, mutual funds, FII’s, provident funds, trusts, corporates and other institutions. The RBI on its part collects auctions bids and gives cut offs on the auctions based on bids for the auctions.
The government bond auction of Rs 15,000 crores held on the 7th of October 2011 saw the total amount of competitive bids for the auction at Rs 27,500 crores. There was no question of this auction seeing bonds go unsold. The RBI chose to devolve or give PD’s some bonds in this auctions as it did not want the auction to clear at the bid levels. The government bond auction of Rs 13,000 crores held on the 14th of October 2011 saw the total amount of competitive bids at Rs 26,125 crores and the RBI chose to devolve part of the auction on PD’s as it did not want to clear the auctions at bid levels.
Devolvement on PD’s can be positive or negative. If RBI chooses to give PD’s bonds instead of giving it to the market at bid levels, it is signaling discomfort with high levels of yields. If the market takes RBI’s discomfort positively, yields will go down and PD’s will make money on the devolvement. On the other hand if market does not want bonds at lower level of yields and PD’s are given bonds on devolvement, bond yields will go up, as PD’s will not be able to sell the bonds given to them through the devolvement.
Understanding the auction process before giving sensationalist headlines is important.
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