If RBI clears OMO with the greenshoe option, market will have to incrementally absorb only Rs 3,000 cr of fresh debt

Government bond yields are likely to trend down on the back of a market friendly open market operations (OMO) purchase window announced by the Reserve Bank of India.

RBI will purchase Rs 6,000 crore of government bonds with a greenshoe option of Rs 3,000 crore on March 5, 2009. The purchase of bonds will be auction-based and on a uniform-price basis.

The OMO announcement comes as a big relief to the market, which has been reeling under an overload of government bond auctions. The market has to absorb Rs 46,000 crore of government bonds in a one month period at the end of the fiscal year. The supply pressures, coupled with traditional year-end pressures on funds, have dented market sentiments, taking bond yields to three-month high levels. The most traded bond, the 8.24% 2018 bond, saw yields touch highs of 6.65% on the back of weak market sentiments.

The OMO auction precedes a Rs 12,000 crore government bond auction scheduled for March 6. The bonds to be auctioned are the 6.05% 2019 bond for Rs 8,000 crore, the 8.24% 2027 bond for Rs 2,000 crore and the 6.83% 2039 bond for Rs 2,000 crore.

If RBI clears the OMO with the greenshoe option, the market will have to incrementally absorb only Rs 3,000 crore of fresh supply. The previous OMO on February 19 and the government bond auction for Rs 12,000 crore after the OMO was a disappointment to the market. RBI bought only Rs 5,000 crore from the market, rejecting all the sale bids for the long bond. This dented market sentiments, leading to a sharp rise in yields on the government bond auctions. RBI, after receiving feedback from market participants, has modified the terms of the OMO, to make it more market friendly. This is a clear indication that RBI wants lower yields in the government bond market.

The fall in inflation and the lower-than-expected third quarter GDP growth numbers has given rise to increased expectations of policy rate cuts by RBI. Inflation as measured by the Wholesale Price Index came in at 3.36% for the week ended February 14, 2009. Inflation stood at 3.91% for the previous week, and is expected to trend lower in the coming weeks. GDP growth numbers for the third quarter of fiscal year 2008-09 came in at 5.3% against market expectations of 6.1%. GDP is forecast to grow at 7% this fiscal, and the lower-than-expected third quarter GDP growth has damped growth prospects. The sharp contraction in growth across the globe with GDP numbers for the US, Japan and Eurozone all coming in negative has placed a question mark on domestic growth.

Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility auction of RBI, was in surplus last week. Bids for reverse repo at 4% touched Rs 65,000 crore. Overnight rates were trading around reverse repo levels of 4%. Liquidity is likely to remain easy this week and overnight rates are likely to trade around reverse repo levels. 

Government bonds

Government bonds saw the yield curve steepen week-on-week. The long bond yield moved up by 26 basis points while five-year benchmark bond yields moved down 10bps week-on-week. The five-over-thirty segment of the curve steepened by 34bps to close at 176bps levels. The most-traded bond — the 8.24% 2018 bond — saw yields move down 10bps week-on-week to close at 6.33% levels, while the new 10-year bond, the 6.05% 2019 bond, saw yields come off by 10bps to close at 6.01% levels.

The five-year benchmark bond, the 7.56% 2014 bond, saw yields close down 10bps at 5.80% levels while the long bond, the 6.83% 2039 bond, saw yields move up by 26bps to close at 7.56% levels. Government bond yields are expected to fall on the back of a market friendly OMO announcement by RBI.

RBI conducted a Rs 12,000 crore government bond auction last week. The bonds auctioned were the 7.46% 2017 bond for Rs 7,000 crore, the 8.35% 2022 bond for Rs 3,000 crore and the 7.50% 2034 bond for Rs 2,000 crore.

The cut-offs came in at 6.98%, 7.50% and 7.75%, respectively. The 8.35% 2022 bond and the 7.50% 2034 bond were devolved on primary dealers for Rs 560 crore and Rs 935 crore, respectively.

Treasury bills, corporate bonds and overnight index swaps

Treasury bills (T-bills) yields were flat in the 91-day T-bill auction last week, with the cut-off on the 91-day T-bill auction held on February 20 coming in at 4.79%, against a similar cut-off seen in the previous auction.

The 364-day T-bill auction saw the cut-off coming in higher at 4.65%, against a cut-off of 4.58% in the previous auction. RBI is auctioning Rs 4,500 crore of 91-day T-bills and Rs 1,500 crore of 182-day T-bills this week.

Corporate bonds saw the yield curve steepen with a sharp rally in five-year bonds. Five-year benchmark corporate bond yields rose 20bps on the back of expectations of a cut in the reverse repo rate, while 10-year corporate bond yields moved down by 10bps. Ten-year benchmark credit spreads came off 10bps week-on-week to close at 263bps levels. Corporate bonds are likely to see yields come off on the back of rate cut expectations.

Overnight Index Swaps (OIS) saw the curve steepen on the back of rate cut expectations. The one year OIS yield moved down by 15bps to close at 3.75% levels while the five-year OIS yield closed up by 9bps at 4.93% levels. The one-over-five spread steepened by 24bps to close at 117bps levels. The OIS curve will flatten on the back of the market friendly OMO announcement by the RBI.

Arjun Parthasarathy/ DNA-Daily News & Analysis Source: 3D Syndication