Rukmani Vishwanath

Mumbai, March 10

FOR the first time in close to a decade since their inception, primary dealers (PDs) in debt securities will report losses for the financial year ending 2004-05.

While most of the leading PDs are bracing themselves for significant losses in their balance sheets as a result of the sharp rise in bond yields during the financial year, the smaller ones have already seen substantial erosion in their capital.

In fact, there was a complete erosion of capital in a couple of small PDs, which were promoted by banks. Banking sources said that the parent banks had to infuse additional funds into them so that they could stay afloat.

The current fiscal has been a turbulent one for both banks and PDs alike in terms of their debt market operations, with the WPI inflation peaking to 8.17 per cent in August 2004, followed by the 10-year bench mark yield surging to 7.25 per cent.

Since then inflation has eased to 4.83 per cent, as on the week-ended February 19, 2005, and the 10-year benchmark paper is ruling at 6.57 per cent.

"Most PDs were caught unawares when in June-July 2004, bond yields shot up by 1.2 per cent in a matter of a week alone. That was the first big shock. Prior to that, we haven't had such a bad experience ever. There have been event risks. But never before did yields move in an upward direction on a sustained basis so fast," said the head of a domestic PD.

Bigger PDs were always considered to be the market makers. Therefore, they always carried a huge stock of securities. When the yields started moving up, most market players had to cut positions on the illiquid securities and book losses. No one is holding big positions at this point, said a senior debt market analyst.

Analysts are also of the view that PDs will be able to wipe out the losses incurred in this year in the next fiscal. "They are much more cautious now in taking positions. Next year, even if rates move up they won't go into losses, because now they have learnt to play the game and have prudent risk management systems in place. Profits may not be as high as it used to be in a soft interest rate regime, but they will be able to sustain themselves," said the head of a local PD.

The Reserve Bank of India mooted the PDs scheme in 1996 to give depth and volume to the domestic debt market. The role of PDs was to act as market makers of government securities. The Discount and Finance House of India Ltd (DFHI) and the Securities Trading Corporation of India (STCI) started operating as primary dealers from March 1996. Four more primary dealers, namely, SBI Gilts Ltd, PNB Gilts Ltd, ICICI Securities and Gilt Securities Trading Corporation commenced operations on June 1, 1996. Today there are around 18 PDs, both local and foreign, operating in the country.

(This article was published in the Business Line print edition dated March 11, 2005)
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