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In a bid to sooth bond market concerns over large state borrowings in the second half of the fiscal, the RBI announced open market operations (OMO) purchase of State Development Loans (SDLs) for the first time, as a special case, in its October policy. The first auction of ₹10,000 crore of SDLs on October 22, not only received good response, but experts also believe that future auctions could help narrow the spreads between SDLs and equivalent government securities in certain tenures.
Against the notified amount of ₹10,000 crore, RBI received bids to the tune of ₹15,475 crore, implying a bid-to-cover-ratio (amount of bids received relative to the amount announced) of 1.5:1 times. Top OMO purchases (by amount) included ₹1,505 crore of 7.78 per cent Maharashtra SDL 2029 at a cut-off yield of about 6.5 per cent, ₹1,199 crore of 7.17 per cent Karnataka SDL 2029 at again 6.5 per cent, ₹1,136 crore of 7.2 per cent Karnataka SDL 2029 at 6.47 per cent and ₹950 crore 7.18 per cent Gujarat SDL 2030 at 6.5 per cent.
Certain SDLs of states such as Chhattisgarh, Goa, Jharkhand, and Kerala were not purchased.
“RBI’s new initiative on SDL OMOs for the current financial year has begun stabilising spreads over equivalent government bonds. This is timely considering the relatively higher supply expected of SDLs in the next few months and will go a long way in supporting market sentiment,” said Suyash Choudhary, Head – Fixed Income, IDFC AMC.
Along with the concern over increase in central government borrowings, bond markets have been on the edge over the sharp rise in state borrowings towards the end of the fiscal. An outright OMO purchase of SDLs has eased bond market concerns over the absorption of excess supply of SDLs.
Yields may compress
The cut-off yields for the SDL OMOs ranged between 6.47-6.68 per cent. These yields are more or less close to the market rates as per the recent auctions of SDLs. For instance, the cut-off yields for SDLs of Andhra Pradesh in the OMO purchase stood at about 6.5 per cent. The recent market auction of the state’s SDLs with similar 10-year residual maturity also took place at 6.5 per cent levels. Similarly, SDLs of Maharashtra and Gujarat too were bought at a cut-off yield of 6.5 per cent; recent market auctions were done in the range of 6.5-6.8 per cent.
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“We need to see how the OMOs between SDLs and central government securities sustain. OMOs of SDLs can be a catalyst for spread compression (between SDLs and G-Secs) in some tenures,” said Lakshmi Iyer, Chief Investment Officer (Debt) & Head - Products, Kotak Mahindra AMC.
Spread compression will depend on the choice of stocks (under OMOs) too, she added.
According to Suyash Choudhary, it may be hard to argue for too much tightening of spreads. “The Q4 supply of SDL is expected to be quite large,” he added.
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