WRAP: The govt’s ‘Great Switcheroo’ in FY20; how, where, when, what
Tuesday, Mar 31
By Suyash Pande and Bhaskar Dutta
MUMBAI/NEW DELHI – The current financial year marks a watershed for public debt management in India, as the government for the first time tapped the open market to conduct the exercise of swapping short-term papers with long-term securities. The departure from the earlier practice of conducting such operations on a bilateral basis also enabled the Centre to pull off its largest ever bond switch programme in 2019-20 (Apr-Mar).
Introduced in 2013-14, switch operations are a tool that the Centre generally uses to postpone debt repayments and prevent bunched up redemption pressures in a single year. In the current financial year, the government switched bonds worth a massive 1.65 trln rupees, a good 1.15 trln rupees higher than the originally projected target for gilt switches.
Given that the government is faced with humongous bond redemptions in the coming years, the heavy reliance on gilt switches this year was out of necessity. However, the degree of success that the Centre’s debt switch operations have met with this year owes a lot to the revamped method for conducting them.
This year, not only did the government launch an auction mechanism for switches, it also started offering the most sought after security in the market–the 10-year benchmark government bond. Moreover, the government offered the benchmark securities more cheaply at switch auctions than at weekly primary sales of debt.
Of the total quantum of bonds switched so far this year, the government issued a total of 596.71 bln rupees worth of two 10-year benchmark bonds–238.31 bln rupees worth of the 7.26%, 2029 bond, and 358.40 bln rupees worth of the 6.45%, 2029 bond.
Even including the debt swaps carried out bilaterally between the government and the RBI, a lion’s share of the switch operations were conducted with the open market and primarily involved 10-year papers.
The choice of the benchmark bonds as candidates for switches may have ensured the efficacy of these operations, but a fallout of relying heavily on the 10-year papers was reduction in the shelf life of these securities.
For instance, the outstanding amount on the 6.45%, 2029 gilt, the current 10-year benchmark bond, has already risen to 958.40 bln rupees, despite the fact that the paper was introduced only in early October.
Considering that the government has an informal borrowing cap of 1.2 trln rupees through a single security, this implies the Centre has little room for fresh issuances of the 6.45%, 2029 bond.
The shortened shelf life of 10-year benchmark bonds could well be the new normal now, as the Centre has little option but to carry out switch operations of a huge quantum, give the sheer size of bond redemptions lined up in the coming years.
The average quantum of bonds maturing in the next five years currently stands at a massive 3.5 trln rupees. The target for gilt switches in the next financial year has been set at a record high of 2.7 trln rupees.
TERM PREMIA BLOWOUT
This year, one of the key reasons for hardening term premia, or the difference between yields on long-term bonds and short-term bonds, was the huge supply of longer-duration papers that hit the market through the government’s debt switches. Securities of a longer maturity entail greater risk on bond portfolios.
The spread between the yield on the 6.65%, 2020 bond, the shortest-maturity dated security, and that on the 7.63%, 2059 paper, the longest-duration government bond, currently stands at 199 basis points as against 143 bps at the beginning of the financial year. This is the steepest yield curve in more than a decade and impedes the RBI’s efforts to ensure that its rate cuts translate into lower borrowing costs throughout credit markets.
What was also a pain point for the market this year was the fact that switches of bonds maturing in 2024-25 far outstripped those of papers maturing in the next financial year.
There is no denying that the Centre is hard pressed to bring down repayments in the coming years, but this could have been done closer to when these redemptions occur, instead of pushing them so aggressively this year.
One way that the government’s debt switches could be made less disruptive would be if a larger quantum of these were conducted with the RBI. While this depends on the RBI’s holdings of the applicable bonds, if the central bank were to state upfront the quantum of bond switches planned with the Centre, market participants could plan their investments more adroitly.
Another way to minimise the disruptions caused by switch operations would be for the government to continue swapping illiquid, high-coupon bonds with more liquid securities maturing the same year. The last two rounds of gilt switches in the current year entailed such swaps, with the total quantum of these transactions amounting to 252.17 bln rupees.
While switches of bonds maturing the same year would not ease the government’s redemption pressure, it would help consolidate the number of government securities and augment liquidity in various points of the yield curve.
The target for gilt switches in the coming financial year is a whopping 64% higher than the revised target for the current year and, as such, is a programme in itself, over and above the borrowing programme. All that the bond market hopes for is that the learning from this year is incorporated.
Following are the highlights of the government’s switch operations in 2019-20 (Apr-Mar):
* Total switch so far 1.65 trln rupees vs revised budgeted target of 1.65 trln rupees, July target was 500 bln rupees
* Switched bonds worth 1.23 trln rupees with market, 419 bln rupees with RBI
* Entire switch with RBI was of bonds maturing in FY21
* Of bonds switched with mkt, 475.49 bln rupees worth of papers to mature in FY21
* Of bonds switched with mkt, 561.24 bln rupees worth of papers to mature in FY25
* Of bonds switched with mkt, 83.60 bln rupees worth of papers to mature in FY27
* 238.31 bln rupees worth of 7.26%, 2029 bond issued via switch
* 358.40 bln rupees worth of 6.45%, 2029 bond issued via switch
* 307.91 bln rupees worth of 7.57%, 2033 bond issued via switch
* 235.53 bln rupees worth of 6.18%, 2024 bond issued via switch
Edited by Avishek Dutta
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