Gilts

This devolves on the primary dealers - who will need to pay up. Funny thing is - the 7 6 year bond, a 2015 gilt, wasn't subscribed (short 591 cr.) even with a cut off yield at 7.10%. Just a few weeks back, bidders got in with a 10 year bond at 6.90% yield. (Which, btw, was also 321 cr. short of subscription, at a 7.30% yield) A few weeks, and the appetite for government bonds has degraded dramatically.

Some say it's because corporate credit is reviving, so people would rather lend to corporates at a higher yield. Of course, when as a government you swear to rescue anyone and everyone, obviously money will run to the higher interest rate - after all, if safety exists everywhere, why lend to the government. The moral hazard hits back.

But that may not quite be true. Banks dropped 130,000 cr. into reverse repo - meaning they really have no other use for the money.

Another common grouse was that RBI always sold illiquid bonds. But the benchmark 2019 bond is one of the most heavily traded; even that was undersubscribed.

It's not even like people are ditching bonds like mad. Just yesterday, the RBI tried to buy back bonds - last year's benchmark 10 year, the 2018 bond - at a yield of 7.28%. See, that's a couple basis points off the yield as RBI sold today - very well worth the effort of a year's wait less - and definitely in the "yield curve". Yet, the RBI couldn't buy enough at that yield - the buy-back only got them bonds worth 5,411 cr.

So it's not panic, yet yields are dropping like crazy; just the last few days have seen benchmark yields move from 7.01% to 7.30% - a fairly large move for an otherwise non-volatile bond. Bloomberg says there's no appetite for govt. bonds anymore. But someone forgot to tell the RBI; it's selling another 12,000 cr. next friday.

Being the regulator and watching so much money flowing into rev. repo every day, the RBI could hike the Statutory Liquidity Ratio (SLR) back to 25% (it had reduced SLR to 24% earlier, to help a bad liquidity situation). This extra 1% is about 28,000 cr. that the banks will need to buy SLR securities, government bonds being the most liquid of that variety.

The government's panic pushing of these bonds could be a sign of things to come; things you and I don't know about. Conspiracy theories abound - inflation will rise, so will interest rates, and the government will have to pay more. Or, a big bank or FI will go under, liquidity will drop and there won't be money to chase those bonds. Or, they need the money before swine flu goes berserk and they're afraid to touch your money then, so give it to them now please. Conspiracy theories are only fun if you have illegal substances to go with them.

I've made a miserable 4% gain in about 9 months - nothing to write home about. Luckily I won't pay any taxes on it - all of the money has come in as dividend.

Last week, the auction of 12,000 cr. devolved on primary dealers - meaning, not all of it was subscribed. 285 cr. of a 7 year bond and 630 cr. of a 11 year bond didn't get subscribed. A lot of bond sales have happened by the RBI lately, like most other governments, and the spirit is to sell even more while the going is good. Well, the going doesn't seem to be as good anymore.

What will be interesting is the impact of a bad monsoon on yields - with even lower revenues from the after effects of a bad monsoon, the deficit balloons further. At some point we will need to monetize it - meaning, the RBI will buy bonds directly (or, like in the US, slightly indirectly). Monetization breeds inflation - a fear that is currently not on the radar.

Still, this is all the expected result - nearly everyone in the market thinks of the deficit monetization as a conclusion. Yet, I've seen markets behave in really odd ways - will there be something different this time? Time will tell.

But I'm getting out when I still have a profit; hopefully it won't make me regret it by turning around right now!

The Reserve Bank of India has rejected all the bids received in the auctions held today for the sale of "7.46 per cent Government Stock 2017", "8.35 per cent Government Stock 2022" and "7.50 per cent Government Stock 2034".

It plans to announce in due course the revised date of the auction, the details of the securities, the method of auction, the central bank said in a press release. Meanwhile bond yields have fallen dramatically, with the new benchmark quoting at 6.61% after risng above 7% in the course of the day.

"Traders were hoping to sell their bonds to the central bank in OMO and then ask for a higher yield in the auction. RBI has caught them short by rejecting all bids. Naturally yields have collapsed," said a dealer at ICICI Securities.

I don't believe these dealers one little bit. My strong belief is that they decided to hike yields up so they can get bonds cheap - after all, it's a small market, with a few primary dealers, and FIIs won't screw around ($200m cap per FII, only so many care). So if they pushed the market down, as has been happening over the last few days, they could easily get the bonds at far lower prices. They even short sold the bonds so they could buy back in the auction. (You can short sell bonds by borrowing them).

And when RBI rejected all bids, the rush to cover the short sales has driven yields up from 7.27% (2018) to 6.8% at close. (that's a price move of some 3%).

It's now entirely likely G-Secs will be sold later, or RBI will be much more active in the bond market. With deflation likely in two weeks, printing money isn't a bad alternative, to pay those that RBI buys bonds from. But if RBI chooses not to, gilts are going much lower.

Reasons, they say, is that the government needs to borrow a lot, and the markets will be flooded. But put one more crisis - one bank, one real estate player, or an international credit situation - and people will rush to buy government bonds, regardless of any of these excuses. Yet, prices are going down daily, and it's a cause for worry.

Inflation at 4.39% is much lower and controlled - and if we go this way we're hitting deflation in the second week of April. Rate cuts are very likely, and quite interestingly, if we deflate, the government needn't borrow; it can simply print the money regardless. The deficit is about 45K cr. - which is nothing by most standards.

The fear is that rating agencies will de-rate India - but let me ask you this: Who the F cares about the rating agencies anymore? They were incompetent about Enron, they were incompetent with Lehman, and the fact the Indian government PRINTS our currency should give any Rupee Bond issues a AAA+++ rating, but they won't do it because they're so darn stupid (and of course, biased). At this point we're not even asking for foreign money (and it seems like should we ask, they're all lined up - right now they have a CAP on g-sec investments).

[Note: This might sound like a justification since I own gilt funds. And I'm wondering if it is too - but I'm convinced that within a year, we see 4% yields]

But come on. 50,000 cr. is 1.25% of GDP. This is not a reason for bonds to lose nearly 4 rupees - or 3% - of their price. There has to be some other explanation, my idea being profit booking in general.

Let's see - prices come first, reasons come later. I still see rates at 4% later this year, so I'm holding.