Betting on bonds

With rules on bond investing relaxed, the risk-takers can try and make money from betting while the risk-averse can hedge themselves.

When Mao Zedong banned betting in China in 1949, that nation of compulsive gamblers was not to be deterred — they started betting on things like which crow on the tree would fly next, and when. Dhritharashtra's sons and betting on kingdoms notwithstanding, Indians have never been in the same class as the Chinese. But thanks to the exigencies and temptations of modern day finance, not to mention the persistent importuning by financial sector cowboys, the normally conservative Reserve Bank of India (RBI) has relented and decided to liberalise the rules for betting on very short term bonds — the 91-day treasury bills — issued by the Government. This will help both the risk-lovers and the risk-averse because the former can try and make money from betting and the latter can hedge themselves. Such betting had been allowed last August on long-dated government securities after an earlier attempt in 2003 had failed. Trading volumes since then have been very low but are expected to pick up now as cash settlement has been permitted. Punters can now take a view on what the interest rate will be in a few weeks or months, place their bets accordingly and expect to be paid cash. Until now it was physical delivery only and this had kept volumes low. Net-net, therefore, the market will become more liquid, which is a good thing. But whether it zooms or not remains to be seen. Eventually, it is bound to become very big because of the huge advantages it offers. In the meantime it will help Indian banks and others to learn how the market works. One must hope, though, that the public sector banks will not get carried away as they did in 1985 when the RBI decided to free up short-term interest rates. They got into such a pickle competing with one another that the freedom had to be hastily withdrawn within six weeks.

The need for hedging arises only when there is volatility. So one interesting macroeconomic question the amendment throws up is whether the RBI now expects interest rates to be more volatile. Until now they have tended to move for long periods in just one direction — either down, as from 2001 to 2009, or up since then. In this, India is not unique. In general, globally, central monetary authorities, because they have all adopted the ‘baby steps' approach, have tended to move uni-directionally over long periods until they get to a rate they think is right. This has, however, led to betting on the amount by which the rate will be changed, rather than the direction. In turn, this has forced the central banks to change rates slowly. The cycle is repeated every three months.

This being so, one is obliged to ask: if the direction and quantum are known with 99 per cent certainty, why is there a need to hedge? And if there is no pressing need to hedge, it would be interesting to see which entities decide to troop into the ring and why.

Published on March 11, 2011
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