Indian Bond Markets Breathe Easier Despite Conservative Central Bank Intervention

Since the Covid-19 crisis hit Indian shores, apart from lower interest rates, the Reserve Bank of India has provided long-term liquidity to the markets and dipped in to buy government securities a few times. It has, however, not announced any large scale primary or secondary market government bonds purchases unlike developed market peers. The Indian central bank has also stayed away from a purchase of corporate bonds, which many had argued for.

“From a policy perspective, the RBI would be chuffed with the way the market has behaved so far,” Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership, told BloombergQuint.

“The short-end of the yield curve is very well anchored, and that has spilled over into the corporate bond market as well where yields have come down and access to credit has broadened, to even somewhat weaker players now,” Upadhyay said. He said that the targeted long-term repo operations have had a strong influence on the market and the backstop provided to mutual funds also had a favourable signalling influence.

There are a handful signals suggesting improved debt market conditions, from the normalising of overnight cash rates to a reduction in spreads charged for state government bonds and also some segments of corporate and NBFC debt.

TREPS Stabilises

While banks can park their excess funds under the RBI’s reverse repo window and earn an interest rate of 3.35%, non-banks, like NBFCs, mutual funds and corporate treasuries, can use the tri-party repo or TREPS market for overnight borrowing and lending.

According to data from the Clearing Corporation of India Ltd, rates in the TREPS facility crashed to 0.48% on March 30, as there was a surge in funds being being parked at the overnight facility to avoid risk taking. Since then, rates have stabilised at an average of 2.9%, barring an occasional day of excessively low rates.

To be sure, banks are still parking over Rs 6 lakh crore at the RBI’s reverse repo window but this too is off its peak levels.

T-Bills Still Seeing A Rush Of Investments

The first port of investment remains short-term government securities.

Over the last three months, banks and mutual funds have been aggressively buying short-term government debt, pushing rates down to nearly two decade lows, BloombergQuint reported on June 24. Rates on 182-day treasury bills and 364-day treasury bills fell to the lowest since 2000, while rates on 91-day treasury bills were slightly above their previous lows last witnessed in 2009.

According to Ajay Manglunia, managing director and head of institutional fixed income at JM Financial Products Ltd., while the redemption pressures felt by mutual funds in April and May have ceased, the lack of issuances in commercial paper and certificate of deposits in the past month has pushed fund managers to buy more T-Bills.

“Right now, mutual funds are very liquid and more investors are shifting their money to overnight funds,” he said. “So funds either have to be happy with these lower rates, as they may keep going downward, or they need to decide to take on credit risk.”

Some Money Moves To Short-Dated State Debt

Some money is starting to move up the risk curve towards state government bonds.

Yields on state government bonds have reduced during auctions in June, for a select few states, compared to rates sought in May and April. Credit spreads, or the additional interest charged over government bonds, on state bonds have also declined in June compared to April and May. The drop has been most notable for short-term state government bonds.

The demand for SDLs (state development loans) increased in the past few months, as bank asset-liability management desks would rather purchase these papers that offer better yields over government securities, says Arvind Chari, head of fixed income at Quantum Advisors Pvt.

NBFC And Corporate Bond Spreads Ease

In the non-government segment, rates have fallen across corporate bonds and debt securities of non-bank lenders.

Credit spreads on AAA corporate bonds with a three-year maturity have fallen by 40 bps compared to two months ago and for five-year bonds spreads have reduced by 21 bps.

Similarly, for AA-rated corporate bonds credit spreads have declined from their peak in April and May. On the three-year bond, spreads have fallen by 42 bps and by 16 bps on the five-year bond.

However, according to Bloomberg, credit spreads remain elevated at around 300 bps for A-rated bonds across maturities and over 450 bps for BBB-rated bonds across maturities.

Credit spreads on AAA-rated NBFC bonds have reduced by over 50 bps for bonds maturing in three years and by nearly 20 bps for five-year bonds.

Similarly, credit spreads on AA-rated NBFC bonds have reduced by 30 bps for bonds maturing in three years and by nearly 10 bps for five-year bonds. While spreads for BBB-rated NBFC bonds remain elevated at over 500 bps across maturities.

Pick-Up In Primary Issuance

The lower rates and less volatile environment has also prompted a pick-up in primary market issuance.

Chari said that bond issuance for AAA state-run companies, higher-rated corporates and NBFCs have increased substantially in recent weeks. He, however, doesn’t see risk-taking returning. “Corporate credit risk-taking will still take time as it’s linked to the economic cycle. Till there are signs of stability and growth, things will remain as they are. If there is another round of fiscal stimulus which improves the growth outlook, we may see investors seeking lower-rated credit, but until then maybe a few AAs and only AAA companies will be the beneficiaries,” he said.

There are a lot of transactions coming in from small non-AAA NBFCs as spreads are slowly coming down, says Manglunia. “Duration risk is still at play with mutual funds buying with a maturity of one and a half to two years and some banks buying debt with a less than three-year maturity,” said Manglunia.