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Nomura Says India Needs To Find A New Investor For Its Sovereign Bonds

Nomura says India will need a new investor class to absorb the upcoming supply of government bonds.



A customer handsover India rupee banknotes at a cash counter (Photographer: Dhiraj Singh/Bloomberg)
A customer handsover India rupee banknotes at a cash counter (Photographer: Dhiraj Singh/Bloomberg)

India may find it hard to get buyers for its sovereign bonds as the country’s lenders, flushed with liquidity, become less hungry for government securities. That's according to a new research by Japanese brokerage Nomura.

“As we enter a new fiscal year, one important question investors are asking is whether there is enough demand to absorb the bond supply that begins in April,” Nomura analysts Vivek Rajpal and Prashant Pande wrote in a note. The past reliance of Indian bond markets on banks suggest that a new investor class is needed to absorb the upcoming bond supply, it added.

Bond sales in India have been driven largely by commercial banks and insurance companies. In 2017-18, more than half of the supply was absorbed by lenders, followed by insurers and foreign investors. Liquidity at banks has swelled up since the government's cash purge in November 2016. Now the statutory liquidity ratio in India's banking system is estimated at 29.6 percent, according to Nomura. That's well above the 19.5 percent ratio the Reserve Bank of India requires them to maintain.

Nomura Says India Needs To Find A New Investor For Its Sovereign Bonds

At the same time, banks have been losing money on their bond porfolios as yields have surged due to various reasons like the government’s fiscal constraint, a recent bank fraud and the weakening rupee. The nation's largest lender State Bank of India reported its first quarterly loss in October-December, its worst since 1999, mainly as its treasury operations turned unprofitable.

It is reasonable to assume that bank appetites for bonds will likely decline further.
Nomura

This means that the bond demand dynamics will be largely dependent on what the RBI does and if foreign investors choose to buy. But global funds have been dumping Indian bonds at the fastest pace since December 2016. Foreign holdings of government and corporate notes fell for a fifth straight week.

Currently, foreign portfolio investments are capped at 5 percent of the total outstanding government bonds. And the net supply for the upcoming fiscal is budgeted at around Rs 4.62 lakh crore. Thus, foreign investors won't be able to buy more than Rs 24,000 crore worth of such bonds. “This, in our view, would be too little to compensate for lack of bank demand in the bond market,” Nomura said.

Nomura Says India Needs To Find A New Investor For Its Sovereign Bonds

For foreign investment in Indian government bonds to be meaningful, Nomura estimates the RBI will have to raise the FPI cap by at least one percentage point. Though there are risks of significant debt outflows linked to raising the FPI cap, it said that if done in a gradual manner it would be beneficial over the medium term.

The RBI itself will have a role to play. Last year, open market sales by the central bank left the market with “more supply than it could digest”, Nomura noted. That was to absorb the surplus liquidity. The brokerage expects that as the cash in circulation continues to normalise, liquidity in banks will also diminish. That could open up room for the RBI to conduct around Rs 50,000-60,000 crore worth of OMO buybacks. “If the RBI becomes a net buyer of India bonds in FY19, it should be supportive of bond markets,” Nomura said.

It said developments on foreign exchange intervention will also be an important factor to determine the quantum of OMO buybacks by the RBI in the next fiscal.