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• Risk averse foreign institutional investors have begun shifting to sovereign bonds as a safe haven investment option.This month to date, net FII investment in bonds, mostly government securities amount was $4.07 billion. Net investment in equities was just $ 46 million for the same period.Traders said that while FIIs were temporarily exiting from equity markets, the preference for debt had increased. The purchase of debt was largely high liquidity securities, including, the highly liquid 8.79 per cent coupon bond falling due in 2021.
• Foreign interest in government bonds had resulted in contradictory situation in the bond markets, the traders said. Yields at the long end were being pushed down. The ten-year security for instance is presently down to 8.35 per cent. This was despite the tight cash conditions in the banking system. Bank of Baroda’s General Manager Treasury ADM Chavali said, “There is also a preference for short term securities, like 3 year and 5 year.” This was because some of the 3 and five-year securities offered high yields at the moment.
• But the sudden interest in government securities was also driven largely by risk aversion, traders said. FII’s the traders said saw bonds as a refuge against steep losses. Moreover with the Reserve Bank of India expected to announce some liquidity easing measures during the next year including enhanced open market operations, bond prices are forecast to see further increases. Chavali said, “Bond prices will see some more upsides in the coming weeks.”
• So far this year, the RBI has conducted about Rs 34,000 crore worth of open market operations. Open market operations involved purchase of securities from the banks and primary dealers. The purchase resulted in pushing cash into the banking system. The shift in yields however indicated that demand for credit was also likely to remain low in the medium term. Under normal conditions when there was demand for term credit, yields for long tenor securities tend to be high and low for short tenor securities. However, presently, yield on the short tenor securities as reflected by the 91-day T-bill was 8.4 per cent or higher than the ten-year benchmark security.
• HDFC Bank's chief treasury economist, Abheek Barua said, “The inversion in yield reflects that demand for credit in the long term is not likely to be significant and also uncertainties on the country’s growth.” A lower growth implied that credit demand was also likely to remain low in the coming months, leading to a shift to long-term securities, he added.
• The rising prices for government securities however would benefit the banks bottom lines for the present quarter. Although, the yields in the year yield in the second quarter was 8.4 per cent would imply a gain of just 5 basis points, the traders, benefit was that they were saved from providing any high deprecations this quarter. If that had happened, they said, depreciation losses, provisions for non-performing assets and reduced interest earnings would have pushed bank results into the red.

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