Public Debt Management - A journey toward Debt Management Office

Enhancing the transparency of debt management operations, the Budget Division of the Department of Economic Affairs, Ministry of Finance, GoI has been publishing a quarterly report called “Public Debt Management – Quarterly Report” from the first quarter of FY-2010-11. This is a step towards the establishment of Debt Management Office (DMO) in the Government which has been advocated for quite some time.

The current one is the fifth quarterly report and pertains to the first quarter of the fiscal year 2011-12, viz., Apr-Jun, 2011. The report gives an account of the debt management and cash management operation during the quarter, and attempts a rationale for major activities. The previous other reports are as given below:

Q1FY2010-11, Q1FY2010-11, Q1FY2010-11 and Q1FY2010-11

The main highlights of latest quarterly report of ‘Public Debt Management’:

Section 1: Macroeconomic Developments

1)      The headline inflation (as measured by WPI) remained high, above 9 per cent consistently in last 8 months with the major contributors from non-food articles, fuel & power group, edible oil and cotton textile.

2)      GDP slowed down from 9.4 per cent in Q4FY10 to 7.8 per cent in Q4FY11. There has been a constant downfall in GDP in each quarters of FY 11.

3)      IIP remained subdued in comparison to last year performance; however, the IIP growth showed improvement in June 2011 to 8.8 per cent from 5.9 per cent in May 2011.

4)      Exports and Foreign investments remained robust. While India’s exports during Q1FY12 registered a growth of 45.7 per cent, inflows due to foreign investment increased more than four times. The portfolio investment, considered as the dicey asset to minimize the Current Account Deficit (CAD) remained moderate in the said quarter.

Section 2: Debt Management – Primary Market Operations

1)      The GoI expects to maintain the fiscal deficit for 2011-12 at 4.6 per cent of GDP or at Rs. 4,12,817 crore. However, the figures look unlikely achievable because of lower revenue collection both from tax and non-tax revenues.

2)      During Q1FY12, the total long dated securities issued were Rs. 1,20,000 crore or 28.8 per cent of BE. Considering account repayments of Rs. 13,473 crore, the net amount raised through dated securities stands at Rs. 1,06,527 crore. There was a total devolvement of Rs. 1,506.5 crore.

3)      Two new securities of 7-years and 10-years maturities were issued. Majority of the raising had been done on re-issues which reflects the continued focus on building up adequate volumes under existing securities imparting greater liquidity in the secondary market. G-Secs woth Rs. 54,000 crore and Rs. 36,000 crore were borrowed under the maturity bracket 5-9 years and 10-14 years respectively; while remaining were raised under longer dated tenures.

4)      The weighted average maturity of dated securities issued during Q1FY12 increased to 12.1 years than 10.45 years in Q1FY11. However, the average maturity of outstanding securities as at end-June 2011 declined to 9.58 years from 9.64 years. Also, the weighted average yield increased to 8.36 per cent in Q1FY12 from 7.62 per cent in Q1FY11. The continuous policy rate hikes by RBI put upward pressure on G-Secs which effectively increased the average cost of borrowing. It crossed the average borrowing yield above 8 per cent after FY08 when it borrowed at an average rate of 8.12 per cent. In FY 2003-04, the average yield was as low as 5.71per cent which started increasing since then.

Section 3 – Cash Management

1)      The Reserve Bank manages the government’s cash account; any mis-matches in cash flows are largely managed through issuances of Cash Management Bills, Treasury Bills and access to Ways and Mean Advances (used in deficit) or through buybacks of G-Secs held by RBI (used in surplus mode). The WMA borrowing happens at repo plus 2 per cent and the current limit stands at Rs. 30,000 crore for Q2FY12 and Rs. 10,000 crore between Q3FY12 to Q4FY12.

2)      The cash position remained in deficit mode in Q1FY12 except the first week of April. Henceforth, it remained in deficit mode to the tune of Rs. 50,000 on an average.

3)      The government also issued Cash Management Bills (CMBs) worth Rs. 38,000 crore as an alternative to WMA where borrowing happens at higher relative cost. Against a total maturity of Rs. 20,000, the net CMBs issued remained at Rs. 18,000 crore. The cut-off yield increased gradually as the borrowing limit increased.

Section 4 – Trends in Outstanding Public Debt

1)      The total public debt of the government increased to Rs. 31,49,996 crore at end-June 2011 from Rs. 29,75,628 crore at end-March 2011. The internal debt constituted 90.3 per cent of public debt; among the internal debt, the share of marketable securities accounted for 78 per cent. Overall 30.9 per cent of outstanding stock has a residual maturity of upto 5 years, which implies that over the next five years, one an average, 6.2 per cent of outstanding stock needs to be rolled over every year. Thus, the rollover risk in the debt portfolio remained low.

2)      Banks remained the major holders of G-Secs; the trend continued at 50.4 per cent. Insurance companies on an average hold 22.22 per cent.

Section 5 – Secondary Market

1)      The inflationary concerns, policy rate hikes and fuel price increases including imported inflation in the form of higher commodity prices  were certain factors which raised the 10-year G-Sec yield from 8.01 per cent on end-Mar 2011to 8.33 per cent on end-June 2011. The bond yield curve remained largely flat with the inversion happing at 5 years maturity bracket compared to 10 year yield.

2)      The maturity distribution pattern of dated securities remained largely in 7-10 years bracket (46 per cent) in Q1FY12 compared to 6.9 per cent in Q4FY11. The shift in share of trading volumes shorted to 7-10 years bracket due to launch of new 10-year benchmark paper. However, the above 10 years category declined from 72.5 per cent in Q4FY11 to 41 per cent in Q1 FY12. It was mainly due to increased volume in two papers 8.08% G-Sec 2022 and 8.13% G-Sec 2022 which were traded actively in absence of an active 10-year paper.

Happy Investing! Happy Reading!

- Amar Ranu

Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach

The world had been overleveraging in pre-financial crisis. Post Lehman scathe, there has been talks of deleveraging and the liquidity including debt which seem like a trap again. Paul Krugman from Princeton University and Gauti B. Eggertsson (NeyYork Fed) talk about Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach.


The approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself.

Read more…

RBI Mid-Sept Monetary Policy Review – Loans to become dearer

The hawkish global economy recovery coupled with high inflationary pressures forced the Central Bank to raise Policy Rates at the pace faster than the market expectations. The Central Bank, RBI in its Mid-Quarter Monetary Policy Review increased the repo rate and reverse repo rate under LAF.


• Repo Rate and Reverse Repo Rate under Liquidity Adjustment Facility (LAF) increased by 25 bps and 50 bps to 6 per cent and 5 per cent respectively, thus, bringing out the LAF rate corridor to 1 per cent.
• Bank Rate and CRR (Cash Reserve Ration) retained at the same level of 6 per cent each

Domestic Scenario
The RBI stressed on that fact that Inflation has become a kind of concern; even the new index of headline inflation as measured by WPI suggests that the monthly average of WPI inflation for Q1 of 2010-11 under the new series at 10.6 per cent was about 50 bps lower than the rate of 11.1 per cent under the old series. Inflation rates have reached its peak and are most likely to remain at the same level for the next few months. However, Food Inflation continues to move northwards and touched 14 per cent in Aug 2010 as per new series.

Another concern that the RBI documented that the negative real interest rates have been affecting deposit growth rates of banks as savers look for higher returns elsewhere. The RBI wanted deposit growth rates to increase as accordingly the bond supply will be a thorough affair in its weekly auctions without any devolvement which may put pressure on yields. The trend suggests that higher deposit growth rate require higher demands for federal bonds as the bank need to maintain the SLR requirement.

The RBI also indicated that higher than expected realizations on 3G and BMA auctions combined with robust tax revenues have virtually eliminated the risk of the fiscal deficit overshooting its target of 5.5 per cent, even after the additional demand for grants from the Central Government have come up in the Parliament. The Water God, Monsoon has revived the growth prospects in Agriculture which will contribute to good rabi harvest.

Liquidity – from a large surplus to deficit
From a surplus mode, the liquidity entered into a deficit mode after the July Policy review, thus, making the repo rate as the operative policy rate. The current hike will prompt many banks to raise the lending and deposit rates which will sustain the strength of the transmission mechanism.

Global Factors
The RBI remained elusive of global circumstances where the slow recovery has halted many advanced economies to hold their rates further for an extended period. This led to massive inflows into developing economies including India. Moreover, the weak global demand coupled with strong domestic demand has increased the trade deficit and the current account deficit has also been widening. However, Europe has demonstrated remarkable resilience; China too bounced back with industrial production and trade numbers reviving sharply. “Overall, even as the global environment continues to be a cause for caution, the big picture has not worsened significantly since July”, said RBI in a press note.

Need for the hike in Policy Rates
Though the hike in policy rates were expected but by increasing the Reverse Repo Rate by 50 bps, higher than the market expectation of 25 bps, the RBI has used this opportunity to reduce the LAF rate corridor, which will reduce the expected volatility in overnight rates. Moreover, it also wanted to reduce the impact of negative real interest rates which led to savers to move to alternate products giving higher returns.

Yields to take cues from Inflation and Policy meet

Highlights:

• The bonds remained jittery throughout the week; however, it settled down at low levels as compared to last week closures.

• The Industrial Output Data as measured by Index of Industrial Production (IIP) rose a more-than expected 13.8 per cent in July 2010, or nearly twice the 7.2 per cent seen in last month.

• Retail Inflation and Food Inflation rose over 15 per cent and 11 per cent, causing a concern for RBI which may hike the rates again.

• The market liquidity remained comfortable with the net absorption of Rs. 27,640 crore under LAF window. However, it would remain in deficit mode going forward.

• The market speculation that the current benchmark paper will be replaced have been put on hold after a Senior Finance Ministry official stated that there is adequate headroom in the current 10-year paper and the bond is expected to last for the entire borrowing in FY11.

View & Recommendations:

• The unexpected factory output at 13.8 per cent plus the high inflation figures may prompt the central bank RBI to revise the policy rates upwards. However, the market has already factored into the 25-bps hike in policy rates.

• Bond yields may soften further in view of global economic environment especially from US i.e. better than expected US Employment data.

• The absence of debt sale in the coming week will keep the demand for debt papers high. The real tone will be set after the mid-quarter policy review this week. Any positive surprise will be greeted with a rally in bond prices. The market is likely to focus on domestic data and policy measures. The policy meet will also review the awaited headline inflation figure due on Sept 14, 2010.

Broader Perspectives:
Bond Front
It is concerned that policy makers are running out of ammunition to control inflation and high factory output is also reigning in strongly; the RBI may go for an upward hike in policy rates. However, the mixed sentiments emanating from global markets are preventing RBI from taking any extreme measures. US President Barack Obama commented that US economy was taking longer than expected time to recover from economic shivers. However, the better-than-expected growth in US employment increased the odds of a fifth interest-rate hike this year.

Bond prices moved up with the 10-year benchmark yield witnessing a drop of 7 bps. The benchmark bond 7.80% 2020 yield nosedived from 7.98 per cent to 7.91 per cent. The comment by the Senior Finance Ministry over the continuance of the current 10-year benchmark bond for the remaining fiscal year 2010-11 boosted the sentiments among traders and investors which lapped the bond to make the prices attractive. He added that the government's preference was to borrow through papers of longer maturity, in order to evenly spread out its outstanding. However, the 8.13% G-Sec 2020 eased only 1 bps to 8.04 per cent. The G-Sec volume was also strong as reported in NDS-OM platform; it showed a daily average of Rs. 12,353 crore over the week. The 1-10 year spread also reported a sharp drop from 168 bps to 149 bps.

Bond Supply
The government auctioned securities worth Rs. 11,000 crore last week. The bonds auctioned were the 7.17% 2015 for Rs. 4,000 crore, the 8.13% 2022 for Rs. 4,000 crore and the 8.26% 2027 for Rs. 3,000 crore respectively. The cut-offs were in line with the market expectations which came in at 7.69 per cent, 8.02 per cent and 8.35 per cent. Five State Governments namely Maharashtra, Punjab, Tamil Nadu, Uttar Pradesh and West Bengal conducted the auction of their State Development Loans for combined amount of Rs. 5,300 crore on Sept 07, 2010. Their cut-off yields were in the range of 8.29 per cent to 8.41 per cent.

Liquidity
The liquidity was comfortable throughout the week as measured by bids for Repo and Reverse Repo auctions in Liquidity Adjustment Facility (LAF). The net absorption amount was Rs. 27,640 crore for this week. This week, there won’t be any auction which will ease off the liquidity. However, the advance tax outflow to the tune of Rs. 50,000 will put the liquidity in deficit mode. The average Call and CBLO rates dropped to 4.65 per cent and 4.28 per cent from 4.77 per cent and 4.75 per cent respectively over the week.

Corporate Bonds
Corporate bonds’ yields fell over the week. The 10-year AAA bond ended at a yield of around 8.71 per cent compared to 8.75 per cent. However, the 1-year bond hardened by 15 bps to 7.95 per cent from 7.80 per cent a week earlier. In the primary market, EXIM Bank raised Rs. 100 crore with 5-year paper and another Rs. 100 crore with 10-year paper with an annualized yield of 8.45 per cent and 8.68 per cent.

Liquidity tightened on 3G outflows; RBI introduced ad-hoc liquidity measures

Highlights:

• Bonds take a break from a continuous 5 week rally; the benchmark bond 6.35% 2020 yield moved to 7.55%, up by 18 bps
• Domestic bond market mirrored US Govt. Bonds; US Treasury bonds’ yields rallied on account of poor consumer spending data
• Liquidity took a major hit; the 3G payments coupled with advance tax outflows put a strain on liquidity
• The RBI announced two liquidity easing measures – additional liquidity support up to 0.5% of banks’ NDTL and 2nd LAF (SLAF) on daily basis
• Call rates and inter-bank rates are likely to go up this week


View & Recommendation:
• With yields easing, fund managers have started increasing the average maturity of income funds, thereby, increasing their ranks in terms of returns.
• Investors looking for investments for a shorter period (6 months - 1 year) should invest in Ultra Short Term Funds (erstwhile called as Liquid Plus Funds) while those looking for a longer investment horizon (1.5 - 3 years) should invest in Income Funds.
• Some of the recommended Income Funds are Birla Sun Life Dynamic Bond Fund, ICICI Prudential Income Fund and Kotak Bond Regular Plan.

Broader Perspectives:
Bond Front
Indian bond markets took a break from a 5-week rally mirroring the movements in US Treasury yields and also incorporating the domestic factors such as liquidity crisis. However, the cancellation of weekly auctions looks distant as the government has other payment commitments such as Cash Management Bills worth Rs. 20,000 Cr, Bond maturities worth Rs. 50,000 Cr in July, cut in Treasury Bills auction size limited to Rs. 22,000 Cr along with government funding to Oil Marketing Companies (OMCs) to the tune of Rs. 14,000 Cr.

Earlier, last week, the bonds rallied after an announcement of probable cancellation of bond auctions this week due to liquidity squeeze arising out of 3G outflows and advance tax payments. The 3G outflows alone is sucking liquidity to an extent of Rs. 67,719 Cr.

The 10-year Benchmark Bond 6.35 per cent 2020 yield shot to 7.55 per cent, up by 18 bps over its last week close. The other heavily traded bond 8.20 per cent 2022 saw yields rise by 17bps to 7.80 per cent on weak-on-weak basis. The average trading volume for G-Secs as reported in NDS-OM platform was Rs. 19,985 Cr. Last week, there were 4 trading days only as the banks were closed on Thrusday (May 27, 2010).


Bond Supply
The government auctioned bonds worth Rs. 12,000 Cr. The notified auction amount was Rs. 4,000 Cr, Rs. 5,000 Cr and Rs. 3,000 Cr for 7.38% G-Sec 2015, 7.80% G-Sec 2020 and 8.32% G-Sec 2032 respectively. The bid to cover ratio was highest (2.5 times) in 10-year benchmark paper, the highest traded paper. The cut-off came in at 7.41 per cent, 7.60 per cent and 8.25 per cent respectively. The government will buyback Cash Management Bills worth Rs. 20,000 Cr this week.


Liquidity Desk
The liquidity was tight last week on account of 3G auction payments by Telecom Companies. Moreover, the advance tax outflows as expected on June 15 have also started putting strain on Liquidity. To ease the pressure, the RBI announced special measures to provide liquidity in the system. The RBI allowed banks additional support under the liquidity adjustment facility. The Central Bank will conduct two rounds of LAF operations. It also permitted banks to avail support of up to 0.5 per cent of their Net Demand and Time Liabilities (NDTL), the steps which will provide an additional liquidity support of Rs. 20,000 Cr. Both the measures would be applicable till July 02, 2010

 Corporate Desk
Corporate bond yields hardened across the tenors. The AAA, 10-year paper hardened to 8.67% compared to 8.60% compared to last week. The 1-year bond traded at a yield of 6.65 per cent. This week, corporate bonds’ yields rose less than the government bond yields. The ten-year benchmark AAA spread shrank to 96bps, down by 14 bps. Corporate bond yields are likely to move higher on account of liquidity worries and interest rate spikes.