The RBI rejected all bids for the 7.99% 2017 bond in the last government bond auction. The central bank did not give any reasons for the rejection of the bids, but the reason is not far to seek. The market bid negatively for 7.99% 2017 bond as it is perceived to be an illiquid security given that its outstanding issuance before the Rs 4000 crores auction was Rs 62,000 crores. The single security issuance limit is around Rs 75000 crores and the 7.99% 2017 bond is nearing that limit.
The new thirteen year bond issued in the auction last week saw the cut off come in at 9.15% while the 8.30% 2040 bond saw the cut off coming in at 9.25%. There was partial devolvement on both the bonds with Rs 1505 crores of 9.15% 2024 bond and Rs 861 crores of the 8.30% 2040 bond being devolved on the primary dealers. The high cut off in terms of yields pushed up the yield curve by 20bps to 25bps at the longer end.
The RBI has to seriously weigh its options if it wants the government borrowing program for the rest of the fiscal year to go on smoothly. The market is highly jittery, as yields have continuously been going up since the government upped the bond issuance amount by Rs 53,000 crores. Bond yields have moved up by 60bps since the end of September 2011. Investors are seeing a deep hole in their books due to rise in bond yields as the market has already absorbed Rs 250,000 crores of bonds at lower levels of yields in the first half of this fiscal. The market has no appetite for risk at present and the continuous supply of bonds is further reducing the markets risk appetite.
Markets are also being spooked by liquidity. The average daily bids for repo at 8.5% last week was Rs 110,000 crores against average daily bids of Rs 46,000 crores seen in the week before last. Liquidity may have been impacted by the fact that last week had only three working days and was the first week of the reporting fortnight. However such sharp swings in liquidity is worrying the markets.
The state of government’s finances is not helping the market. The government is running an overdraft of over Rs 50,000 crores with the RBI and is forced to issue cash management bills to bring down the overdraft to limits of Rs 20,000 crores. The government auctioned Rs 15,000 crores of forty two day cash management bills last week. The government accepted only Rs 5000 crores of the Rs 9000 crores of cash management bills in the second auction as bids were at higher levels of yields.
The government rejecting auction bids will not help the market. The market knows that the government needs the money and cannot postpone any auction. The RBI will have to actively manage auctions by a) issuing fresh benchmark bonds and b) reducing the tenor of issuances. The RBI will also have to infuse liquidity into the system, either through a CRR cut (preferable option) or through bond purchases (not preferred).
Corporate bond yields rose almost in tandem with government bond yields with five and ten year AAA corporate bond yields rising by 11bps each week on week. Five and ten year credit spreads came off by 2bps each to close at 59bps and 69bps levels respectively. The sharp rise in non performing loans in public sector banks with SBI’s net non performing loans rising from 1.7% to 2.04% year on year is negative for credit spreads. The statement of the credit rating agency ICRA on rating of the benchmark AAA issuers of PFC and REC is negative for credit spreads. ICRA has spoken on the deteriorating quality of the assets of PFC and REC who have large exposure to state electricity boards whose finances are in a deep mess. Credit spreads are too tight given the credit environment and have to move up.
The interest rate swap curve saw the inversion coming off sharply week on week. One year OIS (Overnight Index Swaps) yields came off by 14bps while five year OIS yields came off by 1bps and the five over one spread came off by 13bps to close at a negative 69bps levels. The spread inversion is likely to come off further as the market starts factoring in liquidity infusing measures by the RBI.