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Market participants, especially banks, in the Government Securities (G-Sec) market, seem to be turning averse to the conversion of short-tenor securitiesinto long-tenor securities, due to fears that a rise in interest rates could adversely impact prices of the latter.
They are avoiding duration risk (the longer the maturity of a bond, the more sensitive it is to changes in interest rates), going by the results of the switch/ conversion auction of 10 G-Secs (for a notified amount of ₹2,000 crore each) conducted by the Reserve Bank of India on Monday.
The aforementioned development comes amid uncertainty triggered by the second wave of thepandemic and its possible deleterious impact on growth and inflation.
The central bank got tepid response in terms of the number of bids received and amount offered at the conversion auction of two G-Secs maturing in 2022 and two in 2023 into a single destination security of long maturity (G-Sec maturing in 2061).
However, the RBI got better response to the conversion of three G-Secs maturing in 2022, two G-Secs maturing in 2023, and one in 2024 into a single destination security of medium maturity (G-Sec maturing in 2035).
Offers placed by participants exceeded the notified amount in the case of conversion of three G-Secs maturing in 2022, one each in 2023 and 2024 into the destination security maturing in 2035.
In the case of the remaining G-Secs, the offers were less than the notified amount.
The RBI has been conducting auction for conversion of G-Secs on third Monday of every month since April 22, 2019.
Bidding in the auction implies that the market participants agree to sell the source security/ies to the Government of India (GoI) and simultaneously agree to buy the destination security from the GoI at their respective quoted prices.
G-Sec yields under pressure
G-Sec yields have been under pressure in the backdrop of the huge government borrowing programme, retail inflation surging to a four-month high of 5.52 per cent in March 2021 (from 5.03 per cent in February 2021) and index of industrial production (factory output) contracting 3.6 per cent in February 2021 (1.6 per cent contraction in January 2021).
How good is G-Sec as an investment option
Referring to the yield on the 10-year benchmark G-Sec rising about 11 basis points to close at 6.1256 per cent on April 15 despite the RBI purchasing this security at an yield of 6.0317 per cent under the G-Sec Acquisition Programme (G-SAP), CARE Ratings, in a note, said: “The market is still not convinced and is demanding higher yields.
“Pressures of government borrowing and high inflation – today’s (April 15) WPI inflation at 7.4 per cent was a major shock. This market will need to be watched as the view of the market is divergent in terms of direction of yields.”
Currently, the benchmark 10-year G-Sec is trading at an yield of about 6.09 per cent.
Market experts say the RBI’s bid to evolve the yield curve in an orderly manner via G-SAP has yet not yielded results as the current yield differential between the 2030 benchmark G-Sec and the 2035 G-Sec is wide at 63 basis points. The yield differential between the benchmark and the 2025 G-Sec is 55 basis points now.
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