Five years ago, government’s domestic maturity profile was too low as short-term floating debts were at Rs5.3 trillion or 54 percent of total government domestic debt. The roll over risk heightened at that time as the government had to retire old debt and issue new frequently, and exposure to interest rates risk was too high.
In 2014, ministry of finance started issuing PIBs in bulk - Rs2.1 trillion PIBs, on net basis, added in nine months during December 2013 – September 2014 versus Rs1.4 trillion in previous 13 years. That helped the debt maturity profile to grow and the rollover risk to subside, but at some cost.
The major chunk of transactions took place in 3-years PIBs, which were maturing in July 2016. In 2014, interest rates were at the upward end of cycle. The policy rate was at its peak of 10 percent between December 2013 – September 2014; and by the time of maturity in July 2016, it came down to 6.0 percent.
At the time of falling rates, government took the hit on issuing long-term bonds in bulk. The opportunity cost of additional interest cost of 2.5 percent (differential between 3-year PIB and 6-M T-Bills) was around Rs50-60 billion per annum.
Post July 2016; PIB stock kept on declining as government was interested in issuing fresh bonds but did not accept low price bids by banks. From June 2016 level of Rs4.9 trillion, the toll came down to Rs3.3 trillion in March 2018. The government’s domestic debt on the flipside kept on increasing and T-bills dominated once again.
The floating debt that came down from (Rs5.3tn) 54 percent of total domestic debt in July 2013 to 36 percent (Rs5.0tn) in July 2016, started moving north again and the toll stood at 53 percent o(Rs8.7tn) in March 2018. Since then, the rollover risk is back. T-Bills are maturing every fortnight as there are six auctions from May-July 2018 - Rs5.1tn in total are maturing and all are targeted to roll over.
In case of PIBs, government is not targeting much due to the lack of market appetite. In fixed PIBs, the targets are Rs50 billion each in three action dates. Same is the case of newly introduced floating rates PIBs where in total Rs150 billion are expected to be raised in three auctions spanning May-July 2018.
In short, PIBs worth Rs300 billion in total is a mere fraction of Rs5.15 trillion T-Bills in the upcoming auction calendar. Hence, the introduction of floating PIBs at this point is symbolic. It’s a welcome addition to thinly traded market with very few products available in the market.
Principally, the floating PIBs can help banks hedge against the interest rates risk as the margins of floating PIBs is to be fixed in the auction, and the rate will change six monthly benchmarked to weighted average yield of 6-M T-Bills. Concurrently, the government’s roll over risk would reduce as market interest in new instrument will improve the maturity profile of the domestic debt.
Having said that, the new instrument is not likely to help in much needed price discovery in the long-term papers. Out of Rs3.3 trillion PIBs, Rs2.2 trillion are held by bank and rest are owned by mutual funds and insurance companies. The latter do not actively trade in the market, and hence not indicative of a long term yield curve.
The government needs to use Rs2.7 trillion in un-funded NSS for market making. Right now, these are single entry debt. What government can do is to issue equivalent amount of PIBs and T Bill after conducting an actuarial valuation of expected maturity of NSS.
The CDNS can use these marketable papers to meet their maturities. The incremental addition of NSS should be double entry backed by government papers, mainly PIBs. The NSS counter in this way can lend to banks and even compete with banks in short-term and long-term papers in the market.
When there will be more bids, the government borrowing cost would come down due enhanced recipients in the market as right now it’s relying on a few big banks’ treasuries for price discovery. The long-term yield curve is of utmost importance for long-term lending by banks in infrastructure and much needed housing mortgage market.
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