States may defer their bond auctions as yields harden

Synopsis

The Reserve Bank of India has reportedly urged state governments to postpone bond auctions to alleviate supply pressure in a saturated market. This move aims to ease competition with key sovereign securities, with a significant portion of state development loans potentially deferred until the fiscal year's end. The central bank signaled this plan during a recent meeting with primary dealers.

Mumbai: The Reserve Bank of India (RBI) has likely urged state governments to push back their bond auctions to ease supply pressure in a saturated market, particularly during weeks when key sovereign securities such as 10-year bonds or green bonds are sold, three bankers aware of the matter said.

A sizeable chunk of state development loan (SDL) issuances could, therefore, be deferred until the end of the fiscal year, when central government bond supply is absent, one of the bankers said. The RBI signalled this plan during a meeting with bank-linked primary dealers last week, another official added. "The central bank hinted that supply pressure from SDLs would be taken care of in a meeting last week," said a treasury official from a private sector bank. Another treasury official from a PSU bank said: "The RBI has asked state governments to reschedule their auctions to ease supply pressure in the market."

The RBI did not respond to ET's emailed queries on the matter.

Supply of bonds has increased amid state elections and reduced revenue after the GST cuts. State governments raised ₹1.21 lakh crore in September, the highest monthly borrowing this fiscal, before decreasing 52% to ₹57,010 crore in October due to high cost of borrowing.

This high cost of borrowing or elevated yields on SDLs have drawn banks seeking higher returns to lend predominantly in state bond auctions scheduled every Tuesday, thus exhausting their weekly investment capacity and leaving little room for central government bond auctions, which are scheduled every Friday.

Yields of benchmark 10 year bonds and state bonds rose after the RBI cut policy rates by 50 basis points to 5.50% in the June policy. Additionally, lower tax collections, fiscal deficit concerns, US tariffs and a supply-demand mismatch caused further hardening of yields.

"Why would one put additional investment in bonds when there have been mark-to-market losses in this and the previous quarter?" said a senior trader from a private bank.

Yields of the 10 year benchmark government bond hardened in Q2 to reach the highest at 6.64% in late August, versus its lowest at 6.12% in June, CCIL data showed. The 10 year yield closed at 6.52% on Friday, Clearing Corporation data showed. Similarly, the spread between a 10 year SDL and a 10 year g-sec widened over 100 basis points in September from usual 30-40 bps due to muted demand. Last week, the central bank cancelled a ₹11,000 crore seven-year auction as demanded yields were above its comfort level. Yields retreated seven basis points, as supply pressures reduced.

The RBI is likely expected to meet banks this week and other market participants like FIMMDA and PFRDA next week for its pre policy consultation meeting.

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