Debt market moves on from practice of aggressively-priced new 10-year bonds

New 10-year coupon at 7.26%; easing inflation offset by large bond supply

The response to the maiden auction of the new 10-year government bond shows that the Indian debt market may have moved on from a practice that existed for long – aggressive pricing of the security that serves as the benchmark for the rest of the sovereign bond yield curve.
 

The Reserve Bank of India on Friday conducted the first auction of a new 10-year bond maturing in 2033. The new 10-year paper shall soon take up the position of the most liquid paper in the secondary market and become the reference point for pricing sovereign bonds of other maturities.
 

Government bonds serve as the pricing barometer for a host of other credit products in the economy, including debt raised by corporate entities.
 

The coupon -- or the rate of interest periodically paid out to the investor -- on the new 10-year bond was set at 7.26 per cent, the same level as the previous 10-year paper. On Thursday, the old 10-year paper settled at a 7.30 per cent yield.
 

Until last year, the practice in the bond market for new 10-year bonds was to price them at a premium of around 8-10 basis points relative to the prevailing yield on the existing 10-year paper.
 

Banks and other market participants would typically rush to corner the prized 10-year paper in its first auction, thereby widening the spread between the coupon on the new 10-year paper and the yield on the erstwhile benchmark bond.
 

A host of factors, including much larger borrowing through the 10-year paper – and consequently introduction of new bonds at much shorter intervals – have contributed to the market’s decision to largely maintain parity in the pricing of new benchmark papers and their predecessors.
 

In the next financial year, the government has announced gross market borrowing of Rs 15.4 trillion. The largest portion of government borrowing is typically conducted in the 10-14-year maturity bracket.
 

“Gone are the days when the new 10-year bond cut-off used to be 8-10 basis points lower than the outgoing 10-year bond. In earlier days, whether the market was bearish, neutral or bullish, the issuance of the new 10-year bond would happen 8-10 basis points lower,” said Vijay Sharma, senior executive vice-president, PNB Gilts.
 

“We are seeing new 10-year bonds now at much shorter intervals. What used to happen was that people used to bid aggressively at the first auction and then sell. When the pricing is far too away from the current 10-year, it is a cost to be paid by those buyers. Now the market has settled to a nominal premium,” he said.
 

Going ahead, the yield on the 10-year paper is seen in a band of 7.20-7.40 per cent as the market balances the opposing forces of the RBI potentially, ending rate hikes and relentless bond supply pressures.
 

“Market sentiment is positive right now. The borrowing programme has not upset the apple cart. The RBI’s policy will now set the course -- if there is any sign of a pause on rate hikes, we could see the yield range shifting,” said Naveen Singh, head of trading, ICICI Securities Primary Dealership.
 

Sharma of PNB Gilts said that in the off-chance of the RBI calling an end to rate hikes as soon as its policy review next week, the yield on the 10-year paper could drop 15-20 basis points.

“We need a much bigger development on the RBI policy front to see a sustained bull run. It will be difficult to break 7.20-7.40 per cent unless there is either a nasty surprise from the RBI or a very big positive surprise in the form of a pause in hikes right away,” he said.