"RBI has told the market that it will participate in almost 1 trln rupees worth of switches this year," a senior treasury official said.
"The bonds that will be switched may not necessarily be the ones that are immediately maturing, but may be across maturities," the official told Cogencis. If a major portion of the government's switches is conducted with the RBI, the bond market would be spared the heavy supply of longer dated securities that these operations typically bring in. In the current financial year ending today, the government conducted switch auctions in the open market on the third Monday of each month. Of the 1.65 trln rupees worth of switches conducted this year, operations worth 1.23 trln rupees were in the open market and 419.2 bln rupees were with the RBI.
Under most of these operations, the government swapped its outstanding short-term bonds with longer-maturity debt, and in some cases, with on-the-run papers of similar maturities. This year, 1.4 trln rupees worth of switch operations involved the issuance of longer dated securities in lieu of bonds with short maturities. As a result, the government's switch operations saw the bond market reeling under the heavy supply of longer dated securities, which entail a greater exposure on bond portfolios. The back-to-back switches in the open market led to a sharp rise in term premia, the amount by which yields on long-term bonds exceed those on short-term bonds. This made for the steepest sovereign yield curve that the Indian bond market had seen in a decade. Earlier, the government's switch operations had not inflicted such pain on the market as these were conducted on a bilateral basis with the RBI or institutional investors, which meant that the additional supply of longer-dated securities did not end up on the books of banks.
DURATION NEUTRAL SWITCHES
Another reprieve for the bond market in the coming financial year could be that a sizeable chunk of switch operations may not involve the issuance of long-term bonds, but merely a swap of papers with similar maturities, sources said. Such operations do not alter the maturity profile of the government's debt, or of the market's bond holdings. Consequently, these do not pile up duration risk on bond portfolios and are a lot more palatable for the market than the debt switches traditionally conducted by the Indian government.
"The RBI told the market that there will be a lot more of same maturity switches next year, which is a good thing because the market had been complaining about the supply of (long) duration papers," another treasury official said. It was only in February that the government started conducting switches between bonds of similar maturities, with the total quantum of such transactions in 2019-20 amounting to 252.17 bln rupees. When the government first started conducting switches in 2013-14, the stated purpose of these operations was to bring down the gilt redemptions lined up in the short-term, and to reduce the rollover risk faced by the government. Later, the scope of such transactions was extended to create space for fresh issuances in shorter-maturity buckets.
The RBI is said to have told market participants that certain switch operations now, especially the ones swapping papers of similar maturities, are intended to give banks an opportunity to book profits on their bond holdings on a large scale, sources said. "The market was told that same-year switches will give a profit booking opportunity, at the same time it will help consolidate the number of outstanding securities and improve liquidity at those points of the curve," the second official said. The government will release its borrowing calendar for Apr-Sep later today, and with that, it may also indicate the schedule of its bond switches for the coming year.
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