Indecisive auctions

Where are interest rates heading? Acceptance of bids, at a relatively high level, in the last PIB auction held two days back, has called an interest rate outlook into question. The cut-off yield on a 10-year paper rose to 12.70 percent, marking a jump of 38 bps compared to the previous PIB auction held last month. With the discount rate unchanged between the two PIB auctions, the higher cut-off rate is largely crusading markets stance, which expects that interest rates have bottomed out. But, here comes a clash. The governments behaviour in the PIB auction doesn chim with its own response in the last Treasury bill auction held a week ago. In the backdrop, rejection of all bids placed in the last Treasury bill auction made a pitch for a lower interest rate - a move which tamped down the expectations of investors, who were itching for a higher interest rate level. Hence, investors are double-minded about the future direction of interest rates and foresee thin participation in the next Treasury bill auction. A drastic fall in the interest rate level is in the larger interest of the government since it will talk down the cost of debt servicing. Quite the reverse, with out a shadow of doubt, investors are less than pleased having parked a huge pool of funds in government securities. As of 31 October 2011, banks (all scheduled banks) are holding Rs.2,244.6 billion worth of treasury instruments, including T-bills, PIB and Ijara Sukuk, on their balance sheets. Out of these, treasury bills accounted for nearly 79 percent of the total sovereign instruments, and are equivalent to nearly 33 percent of the industrys deposit base. Reinvestment risk, arising from rollover of funds at a lower rate, is definitely arousing a frisson of terror. Therefore, the market expects that lenders and the government will continue to drive a hard bargain against each other, until and unless the direction of future interest rates becomes clear.